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 toexamine equilibrium wages and employment

I We will start by assuming output markets and labour marketsare perfectly competitive

I Workers sell labour on an individual basis

I We begin with the single firm’s decision problem, then move tothe market–e.g. “occupation”, “industry”, “region”, etc.–thelevel of aggregation that determines wages

I We then examine the implication of relaxing the perfectcompetition assumption

The Competitive Firm’s Interaction

with the Market

Wage

Employment

Wage

Employment

Wage

Employment

The Competitive Firm’s Interaction

with the Market

I One problem with the previous analysis is that it assumes thatthe 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 inthe long run it is more realistic)

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

Wage

Employment

Implications of Competitive Markets

I Wages are equalized across homogeneous workers andhomogeneous firms

I No involuntary unemployment

I No queues to work

In reality, we may have imperfect competition, imperfectinformation, risk and uncertainty, or a long-run relationshipbetween 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 theindustry demand for labour is obtained by aggregating alllabour demand curves

I If the firm is a monopolist in the product market, then theirlabour 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

Wage

Employment

Imperfect Competition in the Product

Market

I Note that there is no reason that the monopolist should affectthe market wage

I As long as there is a large number of other firms (possibly inother industries) drawing from the labour market, themonopolist will not affect wages

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

Imperfect Competition in the Product

Market

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

I monopolists may ear profits and workers may be part of aunion that collectively bargain for profits to be split amongemployees

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 purchasinglabour 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 aproduct market

I Monopsonists can be either perfectly discriminating ornon-discriminating

I perfectly discriminating = everyone paid reservation wageI 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 laboursupply 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

Wage

Employment

Imperfect Competition in the Labour

Market

I Firm will max profits by hiring labour until MC = MRPN

I discriminating monopsonist: wage determined by intersectionof AC and MRPN

I non-discriminating monopsonist: wage determined by point onAC curve that corresponds to N associated with intersectionof MC and MRPN

I difference between MRPN and w has been called measure ofmonopolistic 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 effects of a policy change on equilibriumemployment and wages

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

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

I Z,X are exogenous variables (meaning they are determinedoutside 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