Labour Economics assignment 1
Chapter Seven Wages and Employment in a Single Labour Market
© 2012 McGraw-Hill Ryerson Ltd.
Prepared by Dr. Amy Peng
Ryerson University
Learning Objectives
Starting with individuals’ labour supply decisions and firms’ labor demand choices, construct market supply and demand curves and compute the equilibrium wage and employment levels.
Contrast the equilibrium level of wage and employment under perfect competition to the case where there is imperfect competition in the market for goods, in the presence of a monopoly, an oligopoly, or monopolistic competition.
Explain why, compared to the case of perfect competition, employment and wages are lower when the firm is a monopsony in the labour market.
Describe how the minimum wage has a negative effect on employment under perfect competition, but that the effect can turn positive when a firm is a monopsony.
Discuss how estimating the effect of the minimum wage on employment has been the source of some controversy.
Chapter 7
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Competitive Firm’s Demand
Perfect competition in both the product and the labour markets
Assumptions:
homogeneous type of labour
price taker and wage taker
Supply of labour is perfectly elastic (horizontal) at the wage rate
Firms can employ all the labour they need at the market wage rate
Market wage rate is set by the aggregate labour market
Chapter 7
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Competitive Product and Labour Markets
Chapter 7
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W
N
Wc
W
N
Wc
W
N
Wc
S
W0
W0
N01
N1
N02
N2
Ni
D=Di
S1
S2
Firm 1
Firm 2
Aggregate Labour Market
Short Run vs. Long Run
In the short run a firm (firms) may raise its (their) demand for additional workers as demand for its (their) product increases.
Given the upward sloping labour supply curve, the wage rate as well as employment will increase in short run.
Short-run wage increases can be a market signal, resulting in increase in the labour force in long run (labour supply curve shifts to the right).
Chapter 7
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The Labour Market in the Short Run and Long Run
Chapter 7
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Labour
0
Wage
D
SS
S1
S’S
Wc
W1
D1
Equilibrium in a Competitive Market
Characteristics of the long run equilibrium and the market-clearing model (neoclassical)
for markets with homogeneous workers and homogeneous jobs, wages will be equalized across workers
absences of “involuntary unemployment”
no queues for jobs or rationing of jobs
Chapter 7
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In Reality…
The market-clearing model is not entirely true
Wages do not adjust quickly to clear the market
Involuntary unemployment is frequent
Large wage differentials exist across homogeneous workers and jobs.
However, the neoclassical model still serves as a useful approximation of the market theory
Chapter 7
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Imperfect Competition
Monopoly
Effects of hiring more labour
marginal physical product of labour falls
marginal revenue falls
sells more output only by lowering the product price
Chapter 7
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Monopolist Versus Competitive Demand for Labour
Chapter 7
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N
NC*
0
W*
NM*
DM = MPPN X MRQ= MRPN
DC = MPPN X PQ= VMPN
Product Market Structure and Departure from Market Wages
Monopolist:
earns higher profits and labour may be able to appropriate some of these profits
may be less cost conscious and may yield to wage demands
sensitive to public image pay higher wages to buy good image
large firms pay higher wages
Chapter 7
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Oligopoly in the Product Market
Few firms
Similar products
Action of one firm affects the others
May depart from market wages because:
Firms earn above normal profits, some of which may be captured by workers since larger firms may pay above-market wages
Chapter 7
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Monopolistic Competition in the Product Market
Many small firms with differentiated products giving the firm some discretion in price setting
Short-Run
Earn Economic Profit
Able to pay higher than the market wage
Long-Run
No Economic Profit
Has to pay the market wage
Chapter 7
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Working with Supply and Demand
Linear Supply and Demand
Setting NS = ND, solve for market equilibrium
Chapter 7
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Working with Supply and Demand
Add a variable (shifter) to the model
Setting NS = ND, solve for market equilibrium
Log-linear
Chapter 7
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Linear Demand and Supply Function
Chapter 7
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N
0
W
ND = a + bW
NS = c + dW
W*
N*
-a/b
-c/d
Slope = 1/f
Slope = 1/b
Unit Payroll Tax
Tax levied on employers
Proportional to the firm’s payroll
CPP/QPP
Workers’ compensation
Unemployment insurance
Health insurance
Often considered “job killers”
Chapter 7
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Incidence of a Payroll Tax
Add a variable (shifter) to the model
Setting NS = ND, solve for market equilibrium
Chapter 7
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The Effect of a Payroll Tax on Employment and Wages
Chapter 7
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N0
W1
W0
A
T
NS
ND(W)
N1
ND(W + T)
B
D
The workers’ share of the tax is given by the vertical distance BC, while the incidence of the tax on employers is the remainder of T, which is given by CD.
C
Monopsony
A monopsony is a large firm relative to the size of the labour market
It influences the wage rate
It can raise wages to attract labour
Will not lose all of its work force if wages are decreased
Upward-sloping labour supply schedule
Chapter 7
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Monopsony
Average cost is the wage rate
Marginal cost is the new wage plus the cost of paying the higher wage to existing workers
Marginal cost is higher than average cost
Profit maximization when MC = VMP
Chapter 7
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Monopsony
Chapter 7
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Wage
0
VMPN = MPPnPQ
S=AC
MC
VM
WM
SM
WC
S0
VMPM
Labour (N)
Nm
Nc
MC is higher than the AC because the firm must raise the wage for all of its existing employees, not
just the marginal employee
hired.
Implications of a Monopsony
Employment is lower than a competitive situation
Restricts employment because hiring additional labour is costly
Higher wages must be paid to intra-marginal workers
Chapter 7
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Characteristics of Monopsonistic Market
Some inelasticity of supply of labour
Most firms have an element of monopsony power in short run
Long run costly problems of recruitment, turnover and morale issues
Examples of monopsony in long run:
would be a one industry town in an isolated region
if workers have specialized skills that are useful mainly in a specific firm
Chapter 7
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Perfect Monopsonistic Wage Differentiation
Existing workers receive higher wages when a monopsony raises the wage rate
seller’s surplus or economic rent
Monopsonist may try to retain some of this seller’s surplus by differentiating it’s work force
Chapter 7
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Perfect Monopsonistic Wage Differentiation
Supply schedule equals to the average cost and marginal cost
Does not have to pay existing workers any more than their reservation wage
Monopsonists may try to conceal higher wages or use nonwage mechanisms to attract additional labour
Chapter 7
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The Ratio of Minimum Wages to Average Wages, Canada and the United States, 1975–2010
Chapter 7
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Minimum Wage Legislation: Impact on Competitive Labour Market
Adverse employment effect
Firms employ less labour at a higher cost
Higher wage encourages more people to seek work
Magnitude of adverse employment effect depends on the elasticity of the demand for labour
Chapter 7
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Minimum Wage Legislation: Impact on Monopsony
Minimum wage (or other form of price fixing) may increase employment:
Reduces monopsony profits
The magnitude of these effects depend on the extent to which the monopsony is associated with workers who are paid below minimum wage
Heuristic Explanation
Practical Importance
Chapter 7
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Monopsony and Minimum Wage
Chapter 7
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MC
S = AC
VMP
N1
N0
MC1
VMP0
W1
W0
S1
If the minimum wage is above W0 , but still below the competitive wage, the resulting marginal cost schedule is given by the minimum wage (W 1 ) until the firm must pay a higher wage in order to attract workers (at N1 ), after which the marginal cost schedule reverts to the original MC schedule (at
MC1 ).
Empirical Evidence and Actual Impact
There is considerable debate about the empirical impact of minimum wages on employment.
Earlier evidence suggests disemployment effect.
Recent Canadian evidence suggests that the short-run effect is small, though the disemployment effect may be higher in the long run.
Chapter 7
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Summary
The determinants of employment and wage rate in a single market under perfect competition
The impact of imperfectly competitive product market on the labour market
The impact and the incidence of payroll taxes on the labour market
Monopsonistic labour market
Minimum wage and monopsonistic labour market
Chapter 7
© 2012 McGraw-Hill Ryerson Ltd.
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