Labor Markets and Labor Unions Chapter 12 Labor Markets and Labor Unions © 2006 Thomson/South-Western

Three Uses of Time Individuals can use their time in three ways Undertake market work  selling time in the labor market in return for income Undertake nonmarket work  using time to produce their own goods and services Spend time as leisure  all nonwork uses of their time

Work and Utility Work is not a pure source of utility, rather it is a source of disutility  the opposite of utility Net utility of work -- the utility of consumption made possible through work minus the disutility of the work itself; usually makes some amount of work an attractive use of part of an individual’s time In the case of market work, the individual’s income buys goods and services

Utility Maximization Within the limits of a 24-hour day, seven days a week, individuals can balance their time among market work, nonmarket work, and leisure in order to maximize utility The rational consumer will attempt to maximize utility by allocating time so the expected utility of the last unit of time spent in each activity is identical

Implications The higher your market wage, other things constant, the higher your opportunity cost of leisure and nonmarket work The higher the expected earnings right out of high school, other things constant, the higher the opportunity cost of attending college

Wages and Individual Labor Supply An increase in the wage affects an individual’s choice between market work and other uses of time in two ways: Substitution Effect Income Effect As wage increases, market work is substituted for other activities  substitution effect of a wage increase

Income Effect A higher wage means a higher income for the same number of hours, so demand for all normal goods increases Leisure is a normal good, so higher income increases the demand for leisure and the allocation of time to market work declines The income effect of a wage increase tends to reduce the quantity of labor supplied to market work

Exhibit 1: Individual Labor Supply Curve for Market Work The individual supply curve slopes upward until a wage of $12 is reached: at $12, the substitution effect dominates – the quantity of labor supplied increases After a wage of $12, the labor supply curve bends backward and the income effect dominates – the quantity of labor supplied decreases

Nonwage Determinants of Labor Supply Supply of labor to a particular market depends on a variety of factors other than the wage Other sources of income Nonmonetary factors Value of job experience Taste for work

Other Sources of Income The willingness to supply time to a labor market depends on income on other sources, including prior savings, borrowing, family support, and similar sources More generally, wealthy people have less incentive to work

Nonmonetary Factors Difficulty of the job: the more difficult the job, the higher the wage must be, all other things being equal Quality of the work environment: the more attractive the working conditions, the more labor an individual will supply to that particular market, other things constant Status of the position: the higher the status, the more labor an individual will supply to that market, other things constant

Exhibit 2: Market Labor Supply Curve The labor supply curves of different individuals do not bend backwards at the same time – here we have three individual supply curves that sum to a market supply curve that slopes upward over the realistic range of wages

Why Wages Differ Wage differences across markets trace to differences in a number of factors Differences in training, education, age, and experience Differences in ability Differences in risk Geographic differences Job discrimination Union membership

Exhibit 3 Average Hourly Wage By Occupation

Why Wages Differ Training, Education, Age, and Experience Some jobs pay more because they require a long and costly training period Fewer individuals are willing to incur the time and expense required Results in a smaller market supply However, extensive training increases the productivity of labor There is increased demand for these skills

Exhibit 4 Age, Education, and Pay

Why Wages Differ Differences in ability Ability Risk Geographics Job discrimination Union membership

Types of Unions A labor union is a group of workers who join together to improve their terms of employment Craft unions are confined to those with a particular skill, or craft Industrial unions include unskilled, semiskilled, and skilled workers in a single industry, such as all autoworkers or all steelworkers.

Collective Bargaining Process by which representatives of union and management negotiate a mutually agreeable contract specifying wages, employee benefits, and working conditions Mediator An impartial observer who listens to both sides separately and then suggests how each side could adjust its position to resolve differences Binding arbitration Process whereby a neutral third party evaluates both sides of the dispute and issues a ruling that both parties must accept

The Strike A strike is a union’s attempt to withhold labor from the firm Purpose of a strike is to stop production, thereby forcing the firm to accept the union’s position Strikes also impose significant costs on union members

Union Wages and Employment A menu of union desires includes higher wages, more benefits, greater job security, better working conditions, and so on Three ways that a union can try to increase wages By forming an inclusive, or industrial, union By forming an exclusive, or craft, union By increasing the demand for union labor

Exhibit 5: Effect of a Union’s Wage Floor In the absence of a union, equilibrium wage is W and equilibrium employment level is E. At the market wage, individual employers face a horizontal, or perfectly elastic, supply of labor, s. (a) Industry (b) Firm Wage rate S Wage rate W W s D d = Marginal revenue product E Labor per period e Labor per period Each firm can hire as much labor as it wants at the market wage of W A firm hires up to the point where labor’s marginal revenue product equals its marginal resource cost, quantity e

Exhibit 5: Effect of a Union’s Wage Floor If the union negotiates a wage above the market-clearing wage at W‘, no labor will be supplied at a lower wage. In effect, the supply of union labor is perfectly elastic at the union wage out to point a. If more than E'‘ workers are demanded, the wage floor no longer applies and the upward-sloping portion, aS, becomes the relevant part of the labor supply curve W'aS. (a) Industry (b) Firm S a Wage rate W' Wage rate W' s' W W s D d = Marginal revenue product E E'' Labor per period e Labor per period For an industry facing a wage floor of W', the entire labor supply curve is W'aS ,which has a kink where the wage floor joins the upward-sloping portion of the original supply curve.

Exhibit 5: Effect of a Union’s Wage Floor Once this wage floor has been established, each firm faces a horizontal supply curve of labor at the collectively bargained wage, W’. Since the wage is now higher, the quantity of labor demanded by each employer declines from e to e' as seen in the right panel. (a) Industry (b) Firm S a W' W' s' Wage rate Wage rate W W s D d = Marginal revenue product E' E E'' Labor per period e' e Labor per period The higher wage leads to a reduction in total employment as shown by the decline from E to E' in the left panel. Each firm faces a horizontal supply curve of labor at the collectively bargained wage  quantity of labor demanded by each employer declines from e to e’

Exhibit 5: Effect of a Union’s Wage Floor At wage W’, the amount of labor that workers would like to supply, E”, exceeds the amount demanded, E’. In the absence of a union, this excess quantity of labor supplied would cause unemployed workers to lower their asking wage. With a union, workers cannot offer to work for less, nor can employers hire them at a lower wage. (a) Industry (b) Firm S a W' W' s' Wage rate Wage rate W W s D d = Marginal revenue product E' E E'' Labor per period e' e Labor per period Because of the excess quantity of labor supplied, the union must somehow ration available jobs, such as awarding jobs based on worker seniority or connections with the union

Effect of Union Wage Floor With the inclusive, or industrial, union the wage rate is higher and total employment lower than would be in the absence of a union Those who cannot find union employment will look for jobs in the nonunion sector, causing the nonunion wage to be driven downward Wages are relatively higher in the union sector for two reasons Unions bargain for wage higher than the market-clearing wage Those unable to find employment in the union sector crowd into the nonunion sector

Exhibit 6 Median Weekly Earnings Are Higher for Union Than Nonunion Workers

Exhibit 7a: Effect of Reducing Labor Supply A successful supply restriction would be shown as the leftward shift from S to S'.

A successful supply restriction Reducing Labor Supply A successful supply restriction Requires that the union: limit its membership force all employers in the industry to hire only union members – a craft union Membership can be restricted with high initiation fees, long apprenticeship periods, difficult qualification exams, and other devices Defended on the grounds that they protect the public

Exhibit 7b: Effect of Increasing Labor Demand Third way of increasing wages is if the union can somehow increase the demand for labor by causing the demand curve to shift from D to D“ This is a more attractive alternative because it increases both the level of employment – E to E''– and the wage rate – W to W' – there is no need to ration jobs among union members

Increasing the Demand for Labor Increase demand for union-made goods Restrict supply of nonunion-made goods Increase productivity of union labor Some claim that unions increase worker productivity by minimizing conflicts, resolving differences, and monitoring workers If this is indeed true, the demand for union labor should increase Featherbedding

Featherbedding Union efforts to force employers to hire more workers than wanted or needed Does not create a true increase in the demand, in the sense of shifting the demand curve to the right Instead, forces firms to hire more labor than they really want or need, thus moving the firm to a point to the right of its true labor demand curve

Recent Trends in Union Membership In 1955, about one-third of wage and salary workers belonged to unions, now only one in seven belongs to a union Government workers make up nearly half of all union members Compared with other industrialized countries, the U.S. ranks relatively low in terms of unionization

Recent Trends in Union Membership Union membership rates vary greatly across states Rates tend to be highest in the Northeast United States and lowest in the South Decline in union membership is due partly to structural changes in the U.S. economy Employment in the industrial sector has been declining, and increasing in the service sector Growth in foreign competition Near disappearance of strikes

Exhibit 8 Unionization Rates by Age and Gender