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 quasifixed 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 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
1
2

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

INTRODUCTION TO LABOUR ECONOMICS & 1.2

PERSONNEL ECONOMICS
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.

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 Services3

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

INTRODUCTION TO LABOUR ECONOMICS & 1.2

PERSONNEL ECONOMICS
Aspect 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.

2. Like capital,
labor is a flow of
services attached
to a stock of
equipment.

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.

3. Unlike capital, the

stock cannot be
bought and sold.

-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.

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.
7. Labor markets are
highly regulated;
the exchange of labor
is both
highly taxed and
subsidized

-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.
-income and payroll taxes
-income support programs
-workplace safety legislation
-immigration policy
-industrial relations legislation
-affirmative action, comparable
worth

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

-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

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PERSONNEL ECONOMICS
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 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 trade-offs. 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

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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 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.