Review of literature and research methods

Labor Econ

The theory of labor demand breaks down into the long and the short runs, defined by whether or not the firm can change all factors of production (Kaufman and Hotchkiss, 2000, p. 171). This generalizes to all firms, and then in the long run, the macroeconomic level of employment. Firms maximize profits employing different factors up to the point where the return from one more unit equals the cost of the last unit. Substitution takes time and investment in machinery, which is where the definition of the short and long runs arises. Each combination results in a particular level of output, a ratio called the "production function." The amount of output an additional unit of labor will produce given fixed capital is called the "marginal product of labor," the change in total output divided by the change in units of labor. This usually falls when too much labor is applied to fixed capital, "diminishing marginal returns," which means "hire until marginal product per hour equals the hourly wage rate," for a competitive firm (see below).

This results in a downward-sloping demand for labor for the firm. We add all firms' demand curves into a "short run market demand for labor" curve, the slope of which is called the "elasticity of demand for labor" (Kaufman & Hotchkiss, 2000, p. 194). The marginal rate of substitution is usually higher in the long run, because less labor applied to more capital usually results in higher profits. Workers counter this with increasing productivity. The resulting effects determine firm size, aggregate employment, wage rates and output in a competitive economy. These ratios change under monopoly, oligopolistic competition or monopsony (the 'company shop' with only one buyer).

The theory of human capital describes investments workers make to increase their future earnings, usually but not always through education (Becker, 1975, p. 16). Education is usually the most expensive investment an individual will incur because they expect higher earnings will ultimately net more than the direct price and the foregone wages the student gives up, depending on years in the labor force and size and payback rate of expenditure. Discount these back to present values, and if return exceeds cost, the individual will invest in the productivity factor. Higher individual earnings result in higher taxes paid, and so we model "social return" in the same way, where tax cost net of lending, deducted from total tax revenue after the investment, discounted to present values, gives us a positive or negative investment decision based on length of time and rates of payback, interest, inflation, internalized defaults etc. The grand result is a combined level of human capital investment based on an upward sloping supply curve and a down-sloping demand curve, with marginal cost / rate of return on the Y axis, and social human capital expenditure on the X axis. The intersection determines the amount of investment in education / productivity factors by all individuals and institutions.

The major criticisms to the Neoclassical model come from the assumption competition holds, namely that individuals act to maximize profit in all scenarios; factor mobility is unlimited; marginal returns to labor don't increase with wage rates, and other simplifications which rarely hold true in the workforce. Nor are all workers the same to the firm (discrimination), and workers' productivity and labor supply decisions change at different wage levels. Then we have to consider frictional unemployment; information asymmetry; product substitution; any number of real constraints that complicate the pure "Marginal Demand for Labor" theory (Kaufman & Hotchkiss, 2000, p. 31).

The main counter to the Neoclassicals arose in the early-mid-20th century Institutional school after Veblen, Commons and Mitchell, ironically at the University of Wisconsin 1920-30. Institutionalist focus on real evidence counters the Neoclassical theory where institution effects went ignored (New School n.d.). The more sociological approach recognizes 'market failures' of discrimination, collective bargaining and incorporation. Evidence surrounds us today in the form of monopolistic energy provision, embedded in every price on every shelf including wages, for example. One criticism on an Institutional line would be the persistence of poverty. If poverty is unwanted, either we allow poverty to persist, it is necessary for Neoclassical models to hold, or the model is flawed. The Institutional thread leads eventually via the London School to the modern "Post-Keynesian," "Behavioral," "Environmental," and other heterodox schools.