16 April 2016

What explains changes in the labour participation rate?

Tens of papers or blog posts have been written in an attempt to explain why the labour participation rate in the US has been low after the recession. Among other factors, the aging of the workforce and disability have been advanced as explanations. However, an obvious reason seems to have been overlooked: low wage rates.

The graph below shows YoY changes in the civilian labour participation rate vs YoY changes in the real median household income between 1984 and 2014, the period for which data on the real median household income are available. It is clear that the two graphs follow roughly the same path.

In microeconomics the concept of economic profit is widely used. To entice a car company to enter the motorcycle market the mere existence of accounting profit in the new market is not sufficient. Profits in the motorcycle market, after considering all costs, must be higher than in the car market. Opportunity costs must be taken into account before making a decision.

It is the same in the labour market. At first sight it may seem odd that an individual should choose to earn no wages rather than some wages, however low. But when a household is regarded as the basic economic unit it makes sense. For instance, if childcare costs are higher than the wage for a new job, it makes economic sense for one parent to forego the job and take care of a child or children.

Category: Economics

Philip George
Understanding Keynes to go beyond him

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