The Labour Market Chapter 11

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The Labour MarketChapter 11

• LIPSEY CHRYSTAL
• ECONOMICS 12e

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Learning Outcomes

• Some long-lasting wage differentials arise from
  differences in skills and educational
  attainments, and some arise from differences in
  age and gender.
• The full characteristics of many of todays
  workers are hard to ascertain in advance, so
  labour market practices evolve to cope with
  imperfect and asymmetric information.

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Learning Outcomes

• Some wage differentials arise from the type of
  market in which labour is sold different wages
  are likely to be produced by competitive markets,
  where there are many buyers and sellers.
• In monopoly markets, in which unions control the
  supply, and in markets in which there are so few
  employers that each has power to influence the
  outcome.

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Learning Outcomes

• Efficiency wages are above the minimum that would
  be required to hire a worker as they contain an
  incentive for the employee to perform well
• Selection and management procedures evolve to
  provide effective monitoring and incentive
  mechanisms
• Internal labour markets within firms are like
  tournaments in which employees compete for
  promotion to more senior and better paid jobs

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INTRODUCTION - THE LABOUR MARKET

• Wage Differentials
• Equilibrium wage differentials can arise among
  jobs because a each requires different degrees
  of physical or mental abilities, b each
  requires different amounts of human capital
  acquired through costly formal education or
  on-the-job training, c some jobs are closed to
  people who could fill them as a result of
  discrimination, and d the factor markets
  related to different jobs have different
  competitive structures.

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INTRODUCTION - THE LABOUR MARKET

• Wage Differentials
• In perfectly competitive factor markets, wages
  are set by demand and supply and there is no
  unemployment in equilibrium.
• In monopolistic markets, wages and employment are
  less than their competitive levels, but there is
  no unemployment in equilibrium.

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INTRODUCTION - THE LABOUR MARKET

• If a union enters a perfectly competitive market,
  it can raise wages above the competitive level at
  the cost of lowering employment and creating a
  pool of persons who would like to work at the
  union wage but cannot.
• If a union enters a monopsonistic labour market,
  it can raise wages and employment to the
  competitive level.

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INTRODUCTION - THE LABOUR MARKET

• If it raises wages beyond that point, employment
  will fall.
• Unions and professional associations can
  sometimes restrict the supply of labour and
  thereby achieve wages above the competitive
  equilibrium without creating a pool of
  unemployed.

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INTRODUCTION - THE LABOUR MARKET

• Minimum-wage laws have a similar effect to the
  setting of wages by unions.
• If the market was monopsonistic before the
  minimum wage is imposed, wages and employment can
  be raised.
• If it was competitive, wages can be raised only
  at the expense of some (possibly small) reduction
  in employment in the affected occupation.

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INTRODUCTION - THE LABOUR MARKET

• Heterogeneity, Incentives, and Monitoring Costs
• Todays labour markets are complicated by the
  fact that brainpower is extremely heterogeneous
  but it is hard for employers to discern the full
  characteristics of individual workers.
• Many employment contracts are relational
  contracts, which do not specify in detail what
  workers have to do.

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INTRODUCTION - THE LABOUR MARKET

• Heterogeneity, Incentives, and Monitoring Costs
• This creates the potential for principal-agent
  problems, where the hired employees act, in part,
  in their own interest rather than that of the
  employer.
• Solutions to the principal-agent problem involve
  some combination of incentives and monitoring.

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INTRODUCTION - THE LABOUR MARKET

• Most skilled, managerial, and professional
  workers now find themselves in an internal labour
  market that has some of the characteristics of a
  tournament.
• Here the main incentive for lower - and
  middle-ranking staff is to achieve promotion.
• Higher pay generally attaches to more senior
  jobs, and the competition to gain promotion can
  be thought of as a tournament.

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The costs and benefits of formal education
S
U
Income earned
L T
L
Age
0
Direct cost of education
Net cost of education
Consumer satisfaction
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The costs and benefits of formal education

• Acquiring human capital through formal education
  beyond minimum school-leaving age implies costs
  now and benefits later.
• Age is plotted on the horizontal axis and income
  earned on the vertical axis.
• Income is zero until age L, which is the minimum
  school-leaving age.
• After that the yellow line, U, shows the income
  of a typical person who leaves school at age L
  and takes the relatively unskilled job.
• The blue line, S, shows the more complicated
  stream of payments and income receipts of someone
  who stays on for T years of formal training after
  age L.
• At first receipts are negative, reflecting the
  net out-of -pocket expenses related to attending
  school and university.

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The costs and benefits of formal education

• Deducting the consumption value placed on being
  at school rather than at work (light yellow area)
  yields the net cost associated with being in
  school.
• Adding this to the income that could have been
  earned by going directly into the labour force at
  age L yields the total cost of the education,
  which is the medium yellow area.
• The benefit is shown by the dark yellow area,
  representing the difference between the income
  earned in the skilled lob that is acquired at
  year L T (line S) and the income that would
  have been earned if the labour force had been
  entered at age L (line U).

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The costs and benefits of formal education

• The investment in human capital could not
  possibly be worthwhile unless the dark yellow
  benefit area exceeded the medium yellow cost
  area.
• The net benefit to a particular individual
  depends on how much he or she discounts the
  future gain in order to compare it with the
  immediate costs.

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Economic Discrimination
DE
D0
Wage rate
Wage rate
Quantity of labour
Quantity of labour
i. Elite market E
ii. Ordinary market O
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Economic Discrimination
S0
DE
D0
SE
Wage rate
E0
Wage rate
w0
E0
w0
q1
q0
q0
Quantity of labour
Quantity of labour
i. Elite market E
ii. Ordinary market O
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Economic Discrimination
S0
DE
SE
D0
S0
SE
E1
Wage rate
E0
Wage rate
w1
w0
E0
E1
w0
w2
q1
q0
q2
q0
Quantity of labour
Quantity of labour
i. Elite market E
ii. Ordinary market O
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Economic discrimination, (i) elite market

• Market E requires above-average skills.When there
  is no discrimination, demand and supply are DE
  and SE.
• Initially the wage rate is w0 and employment is
  q0.
• Now let Y-type workers be barred from E
  occupations.
• The supply curve shifts to SE and the wage
  earned by the remaining workers, all of whom are
  type X, rises to w1.

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Economic discrimination, (ii) ordinary market

• Market O requires only ordinary skills. When
  there is no discrimination, demands and supplies
  are D0 and S0.
• Initially the wage rate is w0 and employment is
  q0.
• Now let type-Y workers be barred from E
  occupations.
• The Y workers put out of work in the E market
  move to the O market, shifting its supply curve
  to S0 .
• The wage earned by the workers in the O market
  falls to w2 .
• Because all Ys are forced into the O occupations,
  their wage is lower than the wages earned in the
  E market.

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Figure 15.4 A Monopsonist Facing Many Sellers
MC
S
Em
wc
Wage rate
wm
D MRP
qm
qc
Quantity of labour
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A monopsonist facing many sellers

• The competitive wage and employment are wc, and
  qc.
• The monopsonist who must pay the same wage to all
  equates the marginal cost of hiring labour with
  labours marginal revenue product, which occurs
  at point Em.
• The firm hires qm workers at a wage of wm,.
  Labours income is shown by the dark yellow and
  dark blue areas enclosed by qm, and wm.
• A perfectly discriminating monopsonist can pay
  each worker his or her supply price, so the S
  curve is also its marginal cost curve.

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A monopsonist facing many sellers

• The firm will hire qc and pay a total income
  equal to the dark and medium blue areas under the
  S curve.
• The monoponist's profits are the light yellow
  area between wm, and wc and the dark yellow area
  between wm and the S curve. (Under perfect
  competition both yellow areas are parts of
  labours income.)

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A Single Union Facing Many Employers
S
D
E1
Wage rate
x
w1
E0
w0
q1
q0
q2
Quantity of labour
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A Single Union Facing Many Employers

• Competitive equilibrium is at E0.
• The union sets the wage at w1.
• This creates a perfectly elastic supply curve of
  labour up to the quantity q2 which is the amount
  of labour willing to work at the wage w1.
• Equilibrium is at E1 with q1 workers employed and
  q2 q1 willing to work at the going wage rate
  but unable to find employment. Labour income is
  shown by the blue area.

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A Single Union Facing a Single Employer
MC
S
wu
x
E0
w0
Wage rate
wm
MRP D
qm
q2
q0
Quantity of Labour
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A Single Union Facing a Single Employer

• The monopsonist facing competitively supplied
  labour is in the equilibrium with qm, workers
  employed at a wage of wm,.
• If a newly entering union sets its wage at w0,
  the supply curve runs from w0 to E0 and then
  rises along the line S.
• Equilibrium is at E0 with employment at q0.
• If the union seeks a wage higher than w0, it must
  accept a lower level of employment than q0.
• The union can, for example, set a wage at wu,
  creating a supply curve that runs from wu to x
  then up the S curve.

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A Single Union Facing a Single Employer

• This yields the same level of employment, qm, as
  when the monopsonist dominated the market.
• But the wage of wu is much higher.
• At that wage rate there are q2 - qm people who
  would like to work but who are unable to find
  employment.