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INTRODUCTION TO LABOUR ECONOMICS & 1.

2 PERSONNEL ECONOMICS
Labour economics can be simply defined as the economic analysis of labour market, where as, business dictionary1 illustrates labour market as (usually) an informal market where workers find paying work, employers find willing workers, and where wage rates are determined.

Definition and coverage of Labor Economics:


Labor economics encompasses many of the most important issues in economics. Most people earn most of their income by selling their labor time. So labor economics deals with the major source of personal income, what determines it, and why it may differ for different individuals. It also deals with the allocation of the most important (in value terms) input into the production process. From a formal context, Labor economics is the field of economics, which examines the organization, functioning, and outcomes of labor markets; the decisions of prospective and present labor market participants; and the public policies, which relate to the employment and payment of labor resources2. Labor economics, as one of the major sub division of economics focuses its attention upon the economics aspects of the problems, insecurities and institutional development associated with labor. Labor economics involves analyzing the determinants of the various dimensions of labor supply and demand, which interact to determine wages, employment, and unemployment. There are many dimensions to labor supply, including demographics (the effects of birth and date rate), immigration and emigration policies (perhaps a brain drain), the labor force participation decision, the hours of work decision (including overtime and moonlighting), education and training (human capital decisions), and the disincentive effects of income maintenance and unemployment insurance policies. Labor demand focuses on how firms vary their demand for labor in response to changes in the wage rate and other costs, including fringe benefits, legislatively imposed costs, and the quasi-fixed costs associated with hiring and training workers. Since labor demand is a derived demand (derived from the demand for the firm's output), it is also influenced by factors such as free trade, global competition, and technological change. Labor market outcomes are also influenced by the type of market structure (the degree of competition), union collective bargaining and various government laws (such as minimum wage laws). In recent time, labor economics has become increasingly empirical, with less emphasis on theory. Among the areas growing or receiving the greatest attention are changes in the wage structures (including occupational, industrial and regional wage differentials, union/non-union wage differentials, and male/female wage differentials, the issue of sex
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www.businessdictionary.com Campbell R. McConnell, Stanley L. Brue, David MacPherson (2005), Contemporary Labor Economics

INTRODUCTION TO LABOUR ECONOMICS & 1.2 PERSONNEL ECONOMICS


discrimination in the labor market), the economics of education, social interactions and personnel economics. The range of topics studied by labor economists today has broadened far beyond those of traditional labor economics.

An overview of Labor Economics:


At first, it is valuable to have a brief overview of our field of study. The overview yields insights as to how the subject matter of various issues of labor market relate to each others. The most aspects of labor economics can be fitted under the headings of microeconomics and macroeconomics. As we know, microeconomics is concerned with the decisions of individual economic units and functioning of specific markets. On the other hand, macroeconomics is concerned with the economy as a whole or with basic aggregates which constitute the economy. Hence, the determination of wage rate and the level of employment in a particular market carpenters in Sylhet or retail clerk in Dhaka- are clearly microeconomic matters. In contrast, the consideration of the average level of real wages, the aggregate levels of employment and unemployment, and the overall price level are issues of in macroeconomics. But some of the subject matters sometimes pertain to both aspects of economics. Labor economics has both microeconomic and macroeconomic dimensions of analysis. Microeconomics focuses upon the determinations of labor supply and demand and the ways in which supply and demand interact to determine wage rates and employment in various labor markets. Labor unions, government, and discrimination all affect labor markets through either supply or demand. Labor market determine the wage structure and the personal distribution of earnings.

INTRODUCTION TO LABOUR ECONOMICS & 1.2 PERSONNEL ECONOMICS


They also generate incentives for labor mobility and migration. Macroeconomics stresses the aggregative aspects of labor markets and , in particular, labor productivity, labor share of national income, the overall level of employment, and the impact of wage upon the price level. The above diagram3 shows the relationship among various contents of labor economics.

Distinction of labor and scope of labor economics Labor possess some distinguishable characteristics than those of other goods or services. Labor services are rented, not sold Suppliers of labor care about the way in which the labor is used Labor productivity is affected by pay and working conditions labor supply is affected by Non-monetary aspects (i.e., leisure time)

Distinction of Labor from other Goods and ServicesAspect of Labor 1. Labor is a factor of production, not a final product. Explanations & Examples Unlike most goods which households buy, labor is one of the few goods they sell. Consequences -income effects work in different ways for labor than other goods; perverse responses like backward-bending labor supply are more likely -the demand for labor is a derived demand, from the demand firms face for their products -the stock must be produced and maintained: education, training are needed. -in most cases, delivery of the flow requires physical presence: quality of the work environment matters -borrowing constraints may matter for human capital investment (education) -human capital investment is riskier than physical capital investment because it is non-diversifiable -a wide variety of prices and market conditions for different labor services can coexist. This gives rise to a distribution of earnings. -compensation and incentive systems need to be designed appropriately -use monopoly/monopsony and search theory to study these markets

2. Like capital, labor is a flow of services attached to a stock of equipment. 3. Unlike capital, the stock cannot be bought and sold. 4. Labor is a very heterogeneous commodity 5. The quality of labor services being supplied is often hard to measure. 6. Sometimes the demanders and/or suppliers of labor have considerable monopoly power.
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The stock in this case is the worker and the skills he/she possesses. The flow is the right to use it for a period of time. -Slavery is prohibited -For various reasons, people cant sell shares in themselves, for example to finance education -Workers are differentiated by type of skill, amount of skill, demographic characteristics. -workers may simply shirk -poor management decisions may not be apparent for years -employers associations, company towns, other monopsonists -unions -search costs, relationship-specific skills and bilateral monopoly.

Campbell R. McConnell, Stanley L. Brue, David MacPherson (2005), Contemporary Labor Economics

INTRODUCTION TO LABOUR ECONOMICS & 1.2 PERSONNEL ECONOMICS


7. Labor markets are highly regulated; the exchange of labor is both highly taxed and subsidized -income and payroll taxes -income support programs -workplace safety legislation -immigration policy -industrial relations legislation -affirmative action, comparable worth -government policy has important effects on labor markets

All these distinguishable characteristics of labor and enormous importance of labor market create the scope of accommodating the labor related economic discussion into a separate sub-discipline of economics i.e, labor economics.

Importance of labor economics


Traditionally, labor economics is linked to the central core of economics by the theories of labor market and wage determination. Most of the grown up population allocate a substantial fraction of their time to the labor market. The labor market is one of the most important mechanisms for transmitting the benefits of economic growth to different groups in society. We are studying the economics of the labor market, but what exactly is the labor market? We can define it simply as all the buyers and sellers of labor services, and the institutions those facilitate that buying and selling. But what are labor services? Labor services are the direct input of human muscle and brainpower into production. Obviously this is very broadly defined, and includes many occupations and tasks. Labor services are distinct from the other major types of inputs, such as raw materials or capital services. But well see that this distinction is not so clear, for we will make use of the idea that people invest in their own skills, which we will think of as human capital. In fact the labor market consists of many markets. Labor markets differ in terms of location, occupation, and skill. A labor market tends to be more like a single market to the extent that there is a high degree of mobility within it. In this sense executives of Dhaka Bank and Dutch-Bangla Bank are probably in the same labor market, but bankers and heart surgeons are not really in the same labor market at all. Keep in mind that not all work is bought and sold in labor markets. Much housework and child care labor, for example, is performed by family members without pay. Such work is not paid for in a market, but it may have important implications for peoples behavior in markets for paid labor, because it constitutes an alternative use of a persons time. Labor economics is an important subject because unemployment is a problem that affects the public most directly and severely. So the full employment (or reduced unemployment) is one of the major goal of many modern governments.

Introduction to personnel economics


Personnel economics (PE) is a relatively new but very active branch of labor economics. The field has developed many ideas about workforce management and optimal personnel

INTRODUCTION TO LABOUR ECONOMICS & 1.2 PERSONNEL ECONOMICS


policies. In addition, the field is highly empirical. This field has grown greatly in importance in the past 20 years. What is PE? A typical definition would describe it as the subfield of labor economics that analyzes the design and effects of personnel policies. A broader definition would recognize the strong complementation of PE with the economics of organizations. The economics of organizations emphasizes the boundaries of the firm, organizational structure, and decision making. These are closely related to personnel policies and involve similar economic tradeoffs. Moreover, they are all of relevance to an executive responsible for setting or overseeing organizational policies. Traditional labor economics focuses on overall labor markets, individual workers embedded in those markets (not just in a single firm at a point in the career), or public policies. PE, by contrast, more often than not takes the perspective of the employer. The typical objective in PE is to understand the optimal design and effects of personnel policies. Instead of analyzing wage levels for the whole economy, a personnel economist might think about how to design a firm's salary system, and whether that system enables the firm to meet its personnel objectives of recruitment, retention, training, or incentives. Empirical work in this area often uses personnel records from a single firm or collects information on the design of personnel policies across a set of firms, precisely because the interest is in how to design those policies. This focus is one of the primary reasons why the field of PE holds promise as an important tool for research on organizational workforce policies. Much of that research is intended to shed light on optimal employment policies for an organization. PE became a strong subfield in its own right, somewhat separate from labor economics, with two developments. The first was the adaptation of the economics of information and other ideas from economic theory to applications inside organizations. As the theoretical ideas advanced, economists (especially those employed in business schools) began applying the ideas to understand the policies that a firm uses for its internal design and management of personnel. Much of this early work was highly theoretical. However, the focus gradually evolved to a more practical focus. A leader in this development was Edward Lazear, who is generally credited as the primary founder of the field of PE. Two excellent examples of his applied theoretical approach are his articles on salaries versus piece rate compensation plans and tournaments. Both provided empirically testable predictions and practically implementable prescriptions. Personnel economists explore how the tools of sorting, signaling, and investments in human capital might be used by a firm to improve the quality of its workforce. They have used the idea of signaling to analyze how a firm can improve recruiting quality by structuring the job offer so that workers who believe themselves to be a good fit are more likely to accept the offer, while those who do not are more likely to reject the offer. Application of economic ideas of sorting can be used to model how to structure a firm's promotion system. Economists have studied the effects of various kinds of promotion systems on the incentives for workers to invest in firm-specific human capital (skills that are valuable to the current employer) or general human capital (skills that are valuable to many employers). PE developed as a subfield of labor economics over the last 20 years. While labor economics tends to focus on labor markets--what happens across firms--PE focuses on what happens within firms. PE has developed to such an extent that it has become recognized as an

INTRODUCTION TO LABOUR ECONOMICS & 1.2 PERSONNEL ECONOMICS


important subfield distinct from labor economics. PE has a large group of researchers and has been very successful in theoretical and empirical research. This line of study has many practical applications for how firms structure themselves and manage their workforces. PE holds great promise for contributing to research on organizational workforces. It is based on the very strong foundation of classical microeconomic theory. This foundation has enabled PE to develop a relatively comprehensive and rigorous way of thinking about organizational design. This way of thinking does not replace traditional ways of studying organizations. However, it does provide a systematic framework for studying many issues using a consisted and tested toolbox. The PE approach is complementary to other approaches but brings many new insights to the study of human resources. The focus of PE is generally on the firm's perspective and on the design and effects of personnel policies. Emphasis has usually been on practical theory that lends itself to empirics. This approach is ideal for studying personnel records or similar data from organizations and for helping such organizations figure out more effective methods of managing their workforces. While public sector organizations have different objectives and constraints than those of private sector organizations, most of the trade-offs that they face are largely the same.

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