Labor Economics

Labor Economics, Sixth Edition by George J. Borjas provides a modern

introduction to labor economics, emphasizing both theory and empirical evidence.

The book uses many examples drawn from state-of-the-art studies in labor

economics literature. The author introduces, through examples, methodological

techniques that are commonly used in labor economics to empirically test various

aspects of the theory. New and hallmark features of the text include:

NEW AND RELEVANT UPDATES: New policy-relevant applications to help

students better understand the theory and new research from recently published

studies have been added to keep the text relevant and state-of-the-art.

CONCISE PRESENTATION OF THE ESSENTIALS: Although the text covers

every major topic in labor economics, it focuses on the essentials, making

it concise and easy to read.

NEW “THEORY AT WORK” BOXES: Several new boxes have been added,

including how the exodus of renowned Jewish scientists from Nazi Germany

affected the productivity of the doctoral students they left behind, the economic

consequences of political discrimination in Hugo Chavez’s Venezuela, and

a discussion of the long-run consequences of graduating from college

during a recession.

STATISTICAL METHOD OF FIXED EFFECTS: An introduction to this methodology

estimates the key parameter that summarizes a worker’s reaction to wage

changes in a labor supply model over the life cycle.

NEW MATHEMATICAL APPENDIX: In response to customer requests, a new

appendix presents a mathematical version of some of the canonical models

in labor economics. None of the material in this appendix is a prerequisite

to reading or understanding the 12 core chapters of the textbook.

To learn more and to access teaching and learning resources, visit

www.mhhe.com/borjas6e

CONCISE AND CURRENT LABOR ECONOMICS

LABOR

ECONOMICS

SIXTH EDITION

GEORGE J. BORJAS

LABOR ECONOMICS

SIXTH

EDITION

BORJAS

MD DALIM #1174517 12/12/11 CYAN MAG YELO BLK

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Labor Economics

Sixth Edition

George J. Borjas

Harvard University

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LABOR ECONOMICS, SIXTH EDITION

Published by McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the

Americas, New York, NY 10020. Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

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All credits appearing on page or at the end of the book are considered to be an extension of the copyright page.

Library of Congress Cataloging-in-Publication Data

Borjas, George J.

Labor economics / George J. Borjas. — 6th ed.

p. cm.

ISBN 978-0-07-352320-0 (alk. paper)

1. Labor economics. 2. Labor market—United States. I. Title.

HD4901.B674 2013

331—dc23

2011038722

www.mhhe.com

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iii

George J. Borjas

George J. Borjas is the Robert W. Scrivner Professor of Economics and Social Policy at

the John F. Kennedy School of Government, Harvard University. He is also a research

associate at the National Bureau of Economic Research. Professor Borjas received his

Ph.D. in economics from Columbia University in 1975.

Professor Borjas has written extensively on labor market issues. He is the author of

several books, including Wage Policy in the Federal Bureaucracy (American Enterprise

Institute, 1980), Friends or Strangers: The Impact of Immigrants on the U.S. Economy

(Basic Books, 1990), and Heaven’s Door: Immigration Policy and the American Econ￾omy (Princeton University Press, 1999). He has published more than 125 articles in books

and scholarly journals, including the American Economic Review, the Journal of Political

Economy, and the Quarterly Journal of Economics.

Professor Borjas was elected a Fellow of the Econometric Society in 1998, and a Fellow

of the Society of Labor Economics in 2004. In 2011, Professor Borjas was awarded the

IZA Prize in Labor Economics. He was an editor of the Review of Economics and Statistics

from 1998 to 2006. He also has served as a member of the Advisory Panel in Economics at

the National Science Foundation and has testified frequently before congressional commit￾tees and government commissions.

About the Author

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To Sarah, Timothy, and Rebecca

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vi

Preface to the Sixth Edition

The original motivation for writing Labor Economics grew out of my years of teaching

labor economics to undergraduates. After trying out many of the textbooks in the market, it

seemed to me that students were not being exposed to what the essence of labor economics

was about: to try to understand how labor markets work. As a result, I felt that students did

not really grasp why some persons choose to work, while other persons withdraw from the

labor market; why some firms expand their employment at the same time that other firms

are laying off workers; or why earnings are distributed unequally in most societies.

The key difference between Labor Economics and competing textbooks lies in its philosophy.

I believe that knowing the story of how labor markets work is, in the end, more important

than showing off our skills at constructing elegant models of the labor market or remem￾bering hundreds of statistics and institutional details summarizing labor market conditions

at a particular point in time.

I doubt that many students will (or should!) remember the mechanics of deriving a labor

supply curve or the way that the unemployment rate is officially calculated 10 or 20 years

after they leave college. However, if students could remember the story of the way the labor

market works—and, in particular, that workers and firms respond to changing incentives

by altering the amount of labor they supply or demand—the students would be much better

prepared to make informed opinions about the many proposed government policies that

can have a dramatic impact on labor market opportunities, such as a “workfare” program

requiring that welfare recipients work or a payroll tax assessed on employers to fund a

national health care program or a guest worker program that grants tens of thousands of

entry visas to high-skill workers. The exposition in this book, therefore, stresses the ideas

that labor economists use to understand how the labor market works.

The book also makes extensive use of labor market statistics and reports evidence

obtained from hundreds of research studies. These data summarize the stylized facts that a

good theory of the labor market should be able to explain, as well as help shape our think￾ing about the way the labor market works. The main objective of the book, therefore, is to

survey the field of labor economics with an emphasis on both theory and facts. The book

relies much more heavily on “the economic way of thinking” than competing textbooks.

I believe this approach gives a much better understanding of labor economics than an

approach that minimizes the story-telling aspects of economic theory.

Requirements

The book uses economic analysis throughout. All of the theoretical tools are introduced

and explained in the text. As a result, the only prerequisite is that the student has some

familiarity with the basics of microeconomics, particularly supply and demand curves. The

exposure acquired in the typical introductory economics class more than satisfies this pre￾requisite. All other concepts (such as indifference curves, budget lines, production func￾tions, and isoquants) are motivated, defined, and explained as they appear in our story. The

book does not make use of any mathematical skills beyond those taught in high school

algebra (particularly the notion of a slope).

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Preface to the Sixth Edition vii

Labor economists also make extensive use of econometric analysis in their research.

Although the discussion in this book does not require any prior exposure to econometrics,

the student will get a much better “feel” for the research findings if they know a little about

how labor economists manipulate data to reach their conclusions. The appendix to Chapter 1

provides a simple (and very brief) introduction to econometrics and allows the student to

visualize how labor economists conclude, for instance, that wealth reduces labor supply,

or that schooling increases earnings. Additional econometric concepts widely used in labor

economics—such as the difference-in-differences estimator or instrumental variables—are

introduced in the context of policy-relevant examples throughout the text.

Changes in the Sixth Edition

Users of the textbook reacted favorably to the substantial rearrangement of material (mainly

of labor supply) that I carried out in the previous edition. The Sixth Edition continues this

new tradition by further tightening up the discussion on labor supply so that the chapter

now contains material that can be roughly done in a week of lectures. In order to maintain

the labor supply discussion at a tractable length (and in keeping with my philosophy that

textbooks are not meant to be encyclopedias), some material that had been a staple in ear￾lier editions is now omitted (specifically, the models of household fertility and household

specialization).

The Sixth Edition continues and expands other traditions established in earlier editions. In

particular, the text has a number of new detailed policy applications in labor economics and

uses the evidence reported in state-of-the-art research articles to illustrate the many uses of

modern labor economics. As before, the text makes frequent use of such econometric tools

as the difference-in-differences estimator and instrumental variables—tools that play a cen￾tral role in modern research in labor economics. In fact, the Sixth Edition introduces students

to yet another tool in our econometric arsenal, the method of fixed effects—a technique that

is widely used to ensure that the empirical analysis is indeed holding “other things equal.”

Most important, a number of users of the textbook have repeatedly requested a more

technical presentation of some of the basic models of labor economics. To accommodate

this request, I have written a Mathematical Appendix that appears at the end of the text￾book. This appendix presents a mathematical version of some of the canonical models in

labor economics, including the neoclassical model of labor-leisure choice, the model of

labor demand, a derivation of Marshall’s rules of derived demand, and the schooling model.

It is very important to emphasize that the Mathematical Appendix is an “add-on.”

None of the material in this appendix is a prerequisite to reading or understanding any of

the discussion in the 12 core chapters of the textbook. Instructors who like to provide a

more technical derivation of the various models can use the appendix as a takeoff point for

their own discussion and presentation. This is the first time that such an appendix appears

in the textbook, so I would particularly welcome any suggestions or reactions that would

be useful in the presentation and organization of the material in the next edition (including

suggestions for additional models that should be discussed).

Among the specific applications included in the Sixth Edition are:

1. Several new “Theory at Work” boxes. The sidebars now include a discussion of the

impact of weather on the consumption of leisure, the link between the human capital

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viii Preface

of kindergarteners and their socioeconomic outcomes decades later, how the exodus of

renowned Jewish scientists from Nazi Germany affected the productivity of the doc￾toral students they left behind, the economic consequences of political discrimination

in Hugo Chavez’s Venezuela, the link between teachers’ unions and student outcomes,

and a discussion of the long-run consequences of graduating from school during a

recession.

2. A careful updating of all the data tables presented in the text, and particularly the data

on unemployment trends in the United States since the financial crisis of 2008.

3. An introduction to the method of fixed effects by noting how this methodology is used

to estimate the key parameter that summarizes how a worker reacts to wage changes in

a model of labor supply over the life cycle.

4. An expanded discussion of the “new” monopsony literature, including estimates of the

labor supply elasticity at the firm level.

As in previous editions, each chapter contains “Web Links,” guiding students to

Websites that provide additional data or policy discussions. There is an updated list of

“Selected Readings” that include both standard references in a particular area and recent

applications. Finally, the Sixth Edition adds one additional end-of-chapter problem in each

chapter.

Organization of the Book

The instructor will find that this book is much shorter than competing labor economics

textbooks. The book contains an introductory chapter, plus 11 substantive chapters. If the

instructor wished to cover all of the material, each chapter could serve as the basis for about

a week’s worth of lectures in a typical undergraduate semester course. Despite the book’s

brevity, the instructor will find that all of the key topics in labor economics are covered.

The discussion, however, is kept to essentials as I have tried very hard not to deviate into

tangential material, or into 10-page-long ruminations on my pet topics.

Chapter 1 presents a brief introduction that exposes the student to the concepts of labor

supply, labor demand, and equilibrium. The chapter uses the “real-world” example of the

Alaskan labor market during the construction of the oil pipeline to introduce these concepts.

In addition, the chapter shows how labor economists contrast the theory with the evidence,

as well as discusses the limits of the insights provided by both the theory and the data. The

example used to introduce the student to regression analysis is drawn from “real-world”

data—and looks at the link between differences in mean wages across occupations and

differences in educational attainment as well as the “female-ness” of occupations.

The book begins the detailed analysis of the labor market with a detailed study of labor

supply and labor demand. Chapter 2 examines the factors that determine whether a person

chooses to work and, if so, how much, while Chapter 3 examines the factors that deter￾mine how many workers a firm wants to hire. Chapter 4 puts together the supply decisions

of workers with the demand decisions of employers and shows how the labor market

“balances out” the conflicting interests of the two parties.

The remainder of the book extends and generalizes the basic supply-demand frame￾work. Chapter 5 stresses that jobs differ in their characteristics, so that jobs with unpleasant

working conditions may have to offer higher wages in order to attract workers. Chapter 6

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Preface to the Sixth Edition ix

stresses that workers are different because they differ either in their educational attainment

or in the amount of on-the-job training they acquire. These human capital investments help

determine the economy’s wage distribution. Chapter 7 discusses how changes in the rate

of return to skills in the 1980s and 1990s changed the wage distribution in many industri￾alized economies, particularly in the United States. Chapter 8 describes a key mechanism

that allows the labor market to balance out the interests of workers and firms, namely labor

turnover and migration.

The final section of the book discusses a number of distortions and imperfections in

labor markets. Chapter 9 analyzes how labor market discrimination affects the earnings

and employment opportunities of minority workers and women. Chapter 10 discusses how

labor unions affect the relationship between the firm and the worker. Chapter 11 notes

that employers often find it difficult to monitor the activities of their workers, so that the

workers will often want to “shirk” on the job. The chapter discusses how different types of

pay incentive systems arise to discourage workers from misbehaving. Finally, Chapter 12

discusses why unemployment can exist and persist in labor markets.

The text uses a number of pedagogical devices designed to deepen the student’s under￾standing of labor economics. A chapter typically begins by presenting a number of styl￾ized facts about the labor market, such as wage differentials between blacks and whites or

between men and women. The chapter then presents the story that labor economists have

developed to understand why these facts are observed in the labor market. Finally, the

chapter extends and applies the theory to related labor market phenomena. Each chapter

typically contains at least one lengthy application of the material to a major policy issue, as

well as several boxed examples showing the “Theory at Work.”

The end-of-chapter material also contains a number of student-friendly devices. There

is a chapter summary describing briefly the main lessons of the chapter; a “Key Concepts”

section listing the major concepts introduced in the chapter (when a key concept makes

its first appearance, it appears in boldface ). Each chapter includes “Review Questions”

that the student can use to review the major theoretical and empirical issues, a set of 15

problems that test the students’ understanding of the material, as well as a list of “Selected

Readings” to guide interested students to many of the standard references in a particular

area of study. Each chapter then ends with “Web Links,” listing Web sites that can provide

more detailed information about particular issues.

The supplementary material for the textbook includes a Web site that contains much

of the material that students would ordinarily find in a Study Guide ( www.mhhe.com/

borjas6e ), a Solutions Manual that gives detailed answers to all of the end-of-chapter prob￾lems, PowerPoint presentations that instructors can adapt and edit to fit their own lecture

style and organization, a Test Bank that includes 30 multiple choice questions per chapter,

and a digital image library. Instructors should contact their McGraw-Hill sales representa￾tive to obtain access to both the Solutions Manual and the PowerPoint presentation.

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x

Acknowledgments

I am grateful to the many colleagues who have graciously provided me with data from

their research projects. These data allow me to present the intuition and findings of many

empirical studies in a way that is accessible to students who are just beginning their study

of labor economics. I have also benefited from countless e-mail messages sent by users of

the textbook—both students and instructors. These messages often contained very valu￾able suggestions, most of which found their way into the Sixth Edition. I strongly encour￾age users to contact me ([email protected]) with any comments or changes that they

would like to see included in the next revision. I am grateful to Robert Lemke of Lake

Forest College, who updated the Web site for this edition, helped me expand the menu of

end-of-chapter problems, and collaborated in the Solutions Manual and Test Bank; and

Michael Welker, Franciscan University of Steubenville, who created the PowerPoint pre￾sentation for the Sixth Edition. I am particularly grateful to many friends and colleagues

who have generously shared some of their research data so that I could summarize and

present it in a relatively simple way throughout the textbook, including David Autor,

William Carrington, John Friedman,Barry Hirsch, Lawrence Katz, Alan Krueger, David

Lee, and Solomon Polachek. Finally, I have benefited from the comments and detailed

reviews made by many colleagues on the earlier editions. These colleagues include:

Ulyses Balderas

Sam Houston State University

Laura Boyd

Denison University

Lawrence Boyd

University of Hawaii, West Oahu

Kristine Brown

University of Illinois–Champaign

John Buck

Jacksonville University

Darius Conger

Ithaca College

Jeffrey DeSimone

University of Texas Arlington

Richard Dibble

New York Institute Technology

Andrew Ewing

University of Washington

Julia Frankland

Malone University

Steffen Habermalz

Northwestern University

Mehdi Haririan

Bloomsburg University of Pennsylvania

Masanori Hashimoto

Ohio State University–Columbus

James Hill

Central Michigan University

Jessica Howell

California State University–Sacramento

Sarah Jackson

Indiana University of Pennsylvania–Indiana

Thomas Kniesner

Syracuse University

Cory Koedel

University of Missouri–Columbia

Myra McCrickard

Bellarmine University

Elda Pema

Naval Postgraduate School

Esther Redmount

Colorado College

Jeff Sarbaum

University of North Carolina–Greensboro

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Martin Shields

Colorado State University

Todd Steen

Hope College

Erdal Tekin

Georgia State University

Alejandro Velez

Saint Mary’s University

Elizabeth Wheaton

Southern Methodist University

Janine Wilson

University of California–Davis

All editions of this book have been dedicated to my children. I began work on the first

edition shortly before they began to arrive and the 6th edition is being published while my

children are in college. It has been a most interesting and rewarding time. I am truly lucky

and grateful to have been able to experience it.

Acknowledgments xi

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xii

Contents in Brief

1 Introduction to Labor Economics 1

2 Labor Supply 21

3 Labor Demand 84

4 Labor Market Equilibrium 144

5 Compensating Wage Differentials 203

6 Human Capital 235

7 The Wage Structure 288

8 Labor Mobility 318

9 Labor Market Discrimination 367

10 Labor Unions 417

11 Incentive Pay 463

12 Unemployment 498

MATHEMATICAL APPENDIX:

SOME STANDARD MODELS IN

LABOR ECONOMICS 547

NAME INDEX 558

SUBJECT INDEX 566

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xiii

Contents

Chapter 1

Introduction to Labor Economics 1

1-1 An Economic Story of the Labor

Market 2

1-2 The Actors in the Labor Market 3

1-3 Why Do We Need a Theory? 7

1-4 The Organization of the Book 10

Summary 11

Review Questions 11

Web Links 12

Key Concepts 20

Appendix:

An Introduction to Regression Analysis 12

Chapter 2

Labor Supply 21

2-1 Measuring the Labor Force 22

2-2 Basic Facts about Labor Supply 24

2-3 The Worker’s Preferences 27

2-4 The Budget Constraint 31

2-5 The Hours of Work Decision 33

2-6 To Work or Not to Work? 39

2-7 The Labor Supply Curve 42

2-8 Estimates of the Labor Supply Elasticity 45

2-9 Labor Supply of Women 50

2-10 Policy Application: Welfare Programs

and Work Incentives 54

2-11 Policy Application: The Earned Income

Tax Credit 59

2-12 Labor Supply over the Life Cycle 64

2-13 Policy Application: The Decline in Work

Attachment among Older Workers 74

Theory at Work: Dollars and Dreams 40

Theory at Work: Winning the Lotto Will

Change Your Life 43

Theory at Work: Work and Leisure in Europe

and the United States 48

Theory at Work: Cabbies in New York City 69

Theory at Work: Weather and Leisure 73

Theory at Work: The Notch Babies 75

Summary 79

Key Concepts 80

Review Questions 80

Problems 80

Selected Readings 83

Web Links 83

Chapter 3

Labor Demand 84

3-1 The Production Function 85

3-2 The Employment Decision in the Short

Run 88

3-3 The Employment Decision in the Long

Run 94

3-4 The Long-Run Demand Curve for Labor 98

3-5 The Elasticity of Substitution 105

3-6 Policy Application: Affirmative Action and

Production Costs 106

3-7 Marshall’s Rules of Derived Demand 109

3-8 Factor Demand with Many Inputs 112

3-9 Overview of Labor Market

Equilibrium 114

3-10 Policy Application: The Employment Effects

of Minimum Wages 115

3-11 Adjustment Costs and Labor Demand 126

3-12 Rosie the Riveter as an Instrumental

Variable 133

Theory at Work: California’s Overtime

Regulations and Labor Demand 104

Theory at Work: The Minimum Wage and

Puerto Rican Migration 124

Theory at Work: Work-Sharing in

Germany 132

Summary 139

Key Concepts 139

Review Questions 140

Problems 140

Selected Readings 143

Web Links 143

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xiv Contents

Chapter 4

Labor Market Equilibrium 144

4-1 Equilibrium in a Single Competitive

Labor Market 145

4-2 Competitive Equilibrium across Labor

Markets 147

4-3 Policy Application: Payroll Taxes and

Subsidies 152

4-4 Policy Application: Payroll Taxes versus

Mandated Benefits 161

4-5 Policy Application: The Labor Market

Impact of Immigration 164

4-6 The Economic Benefits from

Immigration 179

4-7 Policy Application: Hurricanes and the

Labor Market 182

4-8 The Cobweb Model 185

4-9 Noncompetitive Labor Markets:

Monopsony 187

4-10 Noncompetitive Labor Markets:

Monopoly 194

Theory at Work: The Intifadah and Palestinian

Wages 146

Theory at Work: The Great Black

Migration 180

Summary 197

Key Concepts 198

Review Questions 198

Problems 198

Selected Readings 202

Web Links 202

Chapter 5

Compensating Wage Differentials 203

5-1 The Market for Risky Jobs 204

5-2 The Hedonic Wage Function 210

5-3 Policy Application: How Much Is a Life

Worth? 215

5-4 Policy Application: Safety and

Health Regulations 218

5-5 Compensating Differentials and Job

Amenities 221

5-6 Policy Application: Health Insurance

and the Labor Market 226

Theory at Work: “People” People 214

Theory at Work: Life On the Interstate 218

Theory at Work: Jumpers in Japan 221

Summary 229

Key Concepts 230

Review Questions 230

Problems 230

Selected Readings 234

Web Links 234

Chapter 6

Human Capital 235

6-1 Education in the Labor Market:

Some Stylized Facts 236

6-2 Present Value 238

6-3 The Schooling Model 238

6-4 Education and Earnings 245

6-5 Estimating the Rate of Return to

Schooling 250

6-6 Policy Application: School Construction

in Indonesia 253

6-7 Policy Application: School Quality

and Earnings 255

6-8 Do Workers Maximize Lifetime

Earnings? 259

6-9 Schooling as a Signal 262

6-10 Postschool Human Capital

Investments 268

6-11 On-the-Job Training 269

6-12 On-the-Job Training and the Age-Earnings

Profile 274

6-13 Policy Application: Evaluating Government

Training Programs 279

Theory at Work: Destiny at Age 6? 249

Theory at Work: War and Children’s

Academic Achievement 258

Theory at Work: Is the GED Better

Than Nothing? 267

Theory at Work: Earnings and

Substance Abuse 278

Summary 281

Key Concepts 282

Review Questions 282

Problems 283

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