Chapter 12Chapter 12

Labor Markets and Unions

Labor Supply and Utility Maximization

• Two sources of utility are important:– The consumption of goods and services– The enjoyment of leisure

• It is a normal good• The more leisure time you have, the less you value an

additional hour of it

Three Uses of Time

• Market work- selling your time in the labor market– Your time becomes your employer’s time

• Non-market work- your time is used to produce your own goods and services.– Laundry– Cooking– Cleaning– Mowing

Three Uses of Time

• Leisure- using your time in non-work pursuits.– Movies– Dinner with friends and family– Hobbies

Work and Utility

• Disutility: the opposite of utility– Sadness or pain

• Increasing marginal disutility: the more you work, the greater the marginal disutility of working another house. – There is always something you do not enjoy about

working.

Utility Maximization

• You attempt to maximize utility by allocating your time so that the expected marginal utility of the last unit of time spent in each activity is identical.– Expected marginal utility of the last hour of

leisure= expected marginal utility of the last hour of market work= expected marginal utility of non-market work

Implications

• The higher your market wage, the higher your opportunity cost of leisure and nonmarket wage, OTHC.– Why do corporate lawyers live downtown?

What are you planning on doing this summer?

What are you planning on doing this summer?

Substitution and Income Effects

• An increase in the wage has two effects on your use of time.– Substitution Effect

• Substitute market work for other activities

– Income Effect• At a higher wage, you are willing to have more leisure

Substitution and Income Effect

• As the wage increases, the substitution effect causes you to work more, but the income effect causes you to work less and demand more leisure.

Backward-Bending Labor Supply Curve

• It slopes upward until a specific wage, then it bends backward above that wage.– The reasoning is once you reach a wage above

that level you incentive structure changes and now you can work less and earn the same amount.

Backward-Bending Labor Supply Curve

• The curve is shape this way because the income effect dominates the substitution effect.– Evidences for this relationship in high earners.– The assumption made is that workers have some

control over the number of hours they work.

Nonwage Determinants of Labor Supply

• Other Sources of Income• Nonmonetary Factors• The Value of Job Experience• Taste for Work

Why Wages Differ

• Training• Education• Age• Experience

LO2

Average Hourly Wage by Occupation, U.S, May 2007

Exhibit 3

LO2

Age, Education, and Pay

Exhibit 4

Differences in Ability

• Winner take all labor markets: markets in which a few key employees critical to the overall success of an enterprise are richly rewarded.– Sports– Music– Acting

Differences in Risk

• If the industry is dangerous, then the pay is generally higher– Ex: the miners in Chile– Construction

Types of Unions

• Labor Union: a group of workers who join together to improve their terms of employment– They date back to early days of national

independence

• Craft Union: Formed in 1886, a union whose members have a particular skill or work at a particular craft

• Industrial Union: A union of both skilled and unskilled workers from a particular industry.

Collective Bargaining

• Collective bargaining is the process by which representative of union and management negotiate a mutually agreeable contract specifying wages, employee benefits, and working conditions.– Goes before membership for a vote– If rejected the union can strike or can continue

negotiations

Mediation

• If negotiations reach an impasse, government officials may ask an independent mediator to step in.

• The mediator is an impartial observer who listens to each side separately and then suggests a resolution.

• If each side is still open to a settlement, the mediator brings them together to work out a contract.

Binding arbitration

• This happens in sections where a strike could harm the public interest, such as police or fire.– A neutral third party issues a ruling that both sides

must accept.

The Strike

• This is a major source of union power• The union’s attempt to stop production to get

their workers the best contract.• They are risky

– No pay– No benefits

Problems with Unions

• The Union will negotiate a higher wage for their members, so each firm will hire less labor.– This applies a reduction in employment (higher

unemployment in the industry)

LO4

Effects of Labor Union’s Wage Floor

S

s

(a) Industry

Wag

e ra

te

W’

W

(b) Firm

D

Wag

e ra

te

W’

W

d=Marginal

revenue product

Labor

per periode0 e’Labor

per periodE0 E’’E’

s’a

No union: market wage is W. Each firm can hire as much labor as it wants. The firm hires more labor until MRP=W: e units of labor; industry employment is E.Union negotiates wage W’, above the market wage W; the supply curve facing the firm shifts up from s to s’. Each firm hires less labor, e’; industry employment falls to E’; excess quantity of labor supplied = E’’-E’.

Exhibit 5

Reducing Labor Supply

• How do they increase wages while avoiding an excess supply of labor supplied?– They reduce the supply of labor by limiting the

membership to the union• Increasing the fees to join the union (membership fee

was $50, it is now $125)• Longer apprenticeship• Tougher qualification exams• More restrictive licensing requirements

Increasing Demand for Union Labor

• Increase demand for union-made goods– Special Interest Groups

• Restrict supply of nonunion-made goods– Example: Tariffs on Foreign Steel

• Increase productivity of union labor– Quit rates are lower under unions, implying less

re-training

LO4

Effects of Labor Union’s Wage Floor

S

s

(a) Industry

Wag

e ra

te

W’

W

(b) Firm

D

Wag

e ra

te

W’

W

d=Marginal

revenue product

Labor

per periode0 e’Labor

per periodE0 E’’E’

s’a

No union: market wage is W. Each firm can hire as much labor as it wants. The firm hires more labor until MRP=W: e units of labor; industry employment is E.Union negotiates wage W’, above the market wage W; the supply curve facing the firm shifts up from s to s’. Each firm hires less labor, e’; industry employment falls to E’; excess quantity of labor supplied = E’’-E’.

Exhibit 5

Featherbedding

• They hire more employers than are needed• The union attempts to dictate not only the

wage but also the quantity that must be hired at that wage, thereby moving employers to the right of their labor demand curve.