Econ labor market policy evaluation

ECON 370 - Chapter 7 - Labour

Economics

Maggie Jones

Wages and Employment in a Single

Labour Market

I Chapter 7 puts the supply and demand of labour together to

examine equilibrium wages and employment

I We will start by assuming output markets and labour markets

are perfectly competitive

I Workers sell labour on an individual basis

I We begin with the single firm’s decision problem, then move to

the market–e.g. “occupation”, “industry”, “region”, etc.–the

level of aggregation that determines wages

I We then examine the implication of relaxing the perfect

competition assumption

The Competitive Firm’s Interaction

with the Market

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The Competitive Firm’s Interaction

with the Market

I One problem with the previous analysis is that it assumes that the firm can actually get all the labour it needs at a given wage

I In the short run this may not always be the case (although in the long run it is more realistic)

I E.g. the firm may have to raise wages in the short run to attract workers

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Implications of Competitive Markets

I Wages are equalized across homogeneous workers and homogeneous firms

I No involuntary unemployment

I No queues to work

In reality, we may have imperfect competition, imperfect information, risk and uncertainty, or a long-run relationship between firms and workers

Imperfect Competition in the

Product Market

Imperfect Competition in the Product

Market

I If the industry is competitive in the product market, then the industry demand for labour is obtained by aggregating all labour demand curves

I If the firm is a monopolist in the product market, then their labour demand curve IS the industry labour demand curve

I Under perfect competition, the firm sets MPN ⇥ P = w⇤, where w⇤ is determined in the market (assumes MR = P)

I The monopolist sets MPN ⇥ MR = w⇤ I as monopolist expands output, MPN AND MR decline

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Imperfect Competition in the Product

Market

I Note that there is no reason that the monopolist should a↵ect the market wage

I As long as there is a large number of other firms (possibly in other industries) drawing from the labour market, the monopolist will not a↵ect wages

I Thus, the monopolist will continue to act as a wage-taker, as was the case under competitive markets

Imperfect Competition in the Product

Market

I However, it doesn’t always appear to be the case that monopolists act as wage-takers

I monopolists may earn profits and workers may be part of a union that collectively bargain for profits to be split among employees

I monopolists may be larger firms where monitoring is costly, and thus a “premium” is paid to workers to prevent shirking

Imperfect Competition in the

Labour Market

Imperfect Competition in the Labour

Market

I It may be the case that the firm is the only firm purchasing labour in a given market

I In this case, the firm has market power in the labour market, in a similar way that we think about market power in a product market

I Monopsonists can be either perfectly discriminating or non-discriminating

I perfectly discriminating = everyone paid reservation wage I non-discriminating = if you increase the wage to attract more

workers, you have to increase the wage of existing workers, too

Imperfect Competition in the Labour

Market

I Both types of monopsony result in an upward sloping labour supply schedule

I Perfectly discriminating: I Average cost and marginal cost curves flatter

I Non-discriminating: I Average cost and marginal cost curves steeper

Example: Discriminating vs

Non-Discriminating

N w TCd TCnd ACd ACnd MCd MCnd 1 5

2 10

3 15

4 20

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Imperfect Competition in the Labour

Market

I Firm will max profits by hiring labour until MC = MRPN I discriminating monopsonist: wage determined by intersection

of MC and MRPN I non-discriminating monopsonist: wage determined by point on

AC curve that corresponds to N associated with intersection of MC and MRPN

I di↵erence between MRPN and w has been called measure of monopolistic exploitation

Working with Supply and Demand

Working with Supply and Demand

I We can use our tools of labour supply and demand is to “simulate” the e↵ects of a policy change on equilibrium employment and wages

I This requires a functional form for labour supply and demand I NS = f(W ; X) I ND = g(W ; X)

I W, NS, ND are endogenous variables (meaning they are determined by the system)

I Z, X are exogenous variables (meaning they are determined outside the system)

I Solving the system requires a market clearing condition, NS = ND, from which we can derive w⇤ and N⇤

Working with Supply and Demand