10.6 Conclusion: Lessons of the model

In this chapter, we saw how interactions in firms are different from those in product markets. In firms, employers have authority over the managers and workers. The employers make the big decisions about the firm and then order managers to implement those decisions. Managers have similar power over workers. The employment contract that governs these interactions transfers authority from the worker to the employer for the employee’s working hours.

Everyday Economics 10.20

A new trend in the labor market is the increased use of algorithms and AI in the hiring process. This blog post from the Institute for the Future of Work describes, in general terms, how these systems work and raises some possible concerns about them. Have you or someone you know ever encountered any of these systems in applying for a job? What was your experience of them? What do you think are some benefits of algorithmic hiring systems? What are the costs of using them? Do you worry about them affecting your job applications?

The labor market is a matching market, where both sides of the market care about whom they will be interacting with. The employer, though, has more power in this market and makes the first move by announcing a job opening and, as we shall see in the next chapter, deciding on the hours and wage to be offered. Analyzing the labor market as a matching market helps us understand why there are such strong benefits to establishing long-term relationships: They allow workers to accumulate firm-specific assets and firms to figure out how best to take advantage of a given worker’s unique qualities. This process involves considerable trial and error on both sides, leading to substantial churn in the labor market.

Analyzing the labor market as a matching market helps us to better understand the role of social networks in the hiring process. An unintended consequence of this process in the United States is the perpetuation of certain types of inequality.

Due to the intense scrutiny by firms of potential workers and the power of employers over workers, the matching process is prone to widespread discrimination. Any biases, prejudices, or misconceptions employers bring to the hiring process may shape their decisions and perpetuate inequalities. In addition, stereotypes and social norms can shape people’s preferences in ways that lead them to perpetuate occupational segregation. Both discrimination and occupational segregation can hurt the economy overall, because potentially good matches are not made for reasons having nothing to do with a worker’s quality.

In the next chapter, we examine the relationship between firms, employers, and workers once the worker has already been hired.

Skills and learning objectives

  1. Reading and interpreting an empirical graph (and its terms)
  2. Defining terms
  3. Interpreting labor market statistics
  4. Modeling and interpreting feedback cycles
  5. Reading organizational charts
  6. Translating a story into an abstract model
  7. Reading comprehension (difficult material)

Concepts to be learned

  1. Labor markets as matching markets
  2. Differences between product markets and labor markets
  3. Role of social networks in labor markets
  4. Labor market discrimination
  5. Occupational segregation
  6. Feedback cycles of inequality

Seeing the Principles in Action

Principle Example Everyday Economics
Interdependence principle You and your partner depend on the workers to operate the Mexican restaurant. The workers also depend on each other. And the workers need you to hire and pay them. Think about a job you or someone you know has had. Why did the employers depend on the workers? How did the workers depend on each other? Why did the workers need a job?
Doing the best you can principle Employers and workers both do the best they can in the labor market by trying to find a good match. You and your partner tried hard to find good matches for each position, and the workers searched for jobs before applying for a job at the restaurant. As you get closer to graduation, how do you plan on finding a job? If you’ve had a job before, how did you find that job? What do employers do to try to ensure that they can find a good match?
Rules of the game principle Institutions, especially legal institutions, shape the employment relationship and hiring process. For example, the outlawing of labor market discrimination in 1964 changed what employers are allowed to do in the hiring process. How do the rules of the game shape what employers and workers can do in the hiring process? Are there different rules of the game for hiring for different jobs and professions? If so, what would be some examples?
Trade-offs and opportunity costs principle You and your partner would face trade-offs when choosing who to hire or whether to keep a worker, as not all workers are the same. Workers face trade-offs when deciding where to work—the opportunity cost of choosing one job is the job you may be giving up. If you’ve ever searched for a job, how did you choose one job over another? Did you worry that by taking the job you did, you were passing up a potentially better option? How do employers deal with a tough choice between two candidates for a job?
Principle of gains from cooperation and conflict of interest You and your partner gain from your employment relationship with the workers, and they gain from their relationship with you. However, there may be conflicts over hours, pay, working conditions, or other aspects of the job. If you’ve had a job, did you benefit overall from having that job? Did you have any conflicts with your employer over the hours, pay, working conditions, or something else? How do employers handle such conflicts?
Principle of individual and societal interests Workers doing the best they can often entails using their social connections to learn about open positions and get hired. However, this behavior can also perpetuate group inequality and intergenerational inequality. Have you or people you know ever used social connections to learn about a job or get hired at a job? If so, do you think you would have gotten a worse job if you hadn’t done that?

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