© 2009 Pearson Education Canada 12/1 Chapter 12 Labour Market Applications

© 2009 Pearson Education Canada 12/2 Minimum Wage Legislation  The real question regarding minimum wage legislations is, “do they help the working poor?” - Does it achieve a desired redistribution of income? - Are workers in the industry “better-off”? - Whose income falls to make up for the rise in minimum wage income? - Is inefficiency an invariable side effect?

© 2009 Pearson Education Canada 12/3 Figure 12.1 Minimum-wage legislation in a competitive labour market

© 2009 Pearson Education Canada 12/4 Minimum Wage in a Competitive Labour Market  In a competitive market, inefficiency is a necessary by-product of an effective minimum wage law.  As labour services are no longer put to their most productive uses, either unemployment or underemployment will signal that inefficiency.  Underemployed workers in Figure 12.1 are those who have a marginal product of $12 in this industry, but choose to work in a less productive industry rather than face the chance of unemployment.

© 2009 Pearson Education Canada 12/5 Monopsonistic Labour Markets  A monopsonistic labour market has a single buyer of labour.  The implications of minimum-wage legislation are very different compared to a competitive market.  Figures 12.2 and 12.3 illustrate why this is the case.

© 2009 Pearson Education Canada 12/6 Figure 12.2 Minimum wage and a monopsonist’s marginal factor cost

© 2009 Pearson Education Canada 12/7 From Figure 12.2  Once a minimum wage is brought into a monopsony, the marginal factor cost (MFC) will change.  The monopsonist’s pre-legislation MFC is the line segment DBC.  The post-legislation MFC is now two lines, w’A and BC.

© 2009 Pearson Education Canada 12/8 From Figure 12.2  If the monopsonist hires an amount of labour less than z’, its MFC is w’.  If it hires beyond that point, its MFC is segment BC of its original MFC function because it can hire additional workers only at a wage rate higher than w’.

© 2009 Pearson Education Canada 12/9 Figure 12.3 Minimum wage and monopsony

© 2009 Pearson Education Canada 12/10 From Figure 12.3  Does a minimum wage increase workers’ incomes?  Yes. As long as the wage is not higher than w”’, some workers are better off and none worse off. Why? - At w* or below, it has no effect. - At above w* but below w’’’, workers hired before the introduction of the minimum wage will be paid more and new workers will be hired at the new (minimum) wage. -If the rate is w”’, no new workers are hired, but existing workers will be paid more.

© 2009 Pearson Education Canada 12/11 Minimum Wage Legislation  The attractiveness of minimum wage legislation depends upon whether labour markets are competitive or monopsonistic.  Empirical evidence suggests that labour markets covered by minimum wage laws are competitive, and the laws are problematic.

© 2009 Pearson Education Canada 12/12 Minimum Wage Legislation  Workers who remain employed are better off. It is not clear at whose expense the gain is made (we do not know who pays).  By creating unemployment and underemployment, the legislation will hurt some people it was intended to help.

© 2009 Pearson Education Canada 12/13 Union Wage Rates  Although analyzing the economic consequences of unionization objectively is not easy, we can move in that direction by adapting our minimum-wage analysis to apply to union wages rates.  In this analysis, the union wage is treated like a wage floor - setting a minimum wage paid in a unionized industry.

© 2009 Pearson Education Canada 12/14 Figure 12.4 A wage floor in the two- sector model of the labour market

© 2009 Pearson Education Canada 12/15 From Figure 12.4  Imposing the wage floor means that some workers are reallocated from sector 1 to sector 2 and as a result, the wage rate in sector 2 falls.  Because $6 is less than the competitive wage of $9, workers are not allocated to their most productive jobs.  The wage floor yields an equilibrium with underemployment.

© 2009 Pearson Education Canada 12/16 From Figure 12.4  Assume there are unionized and non- unionized sectors and that the unionized sector is characterized by a “shape up” (all members turn up each day and a union official picks the members who work that day).  Workers are free to seek work in either sector. The number of workers looking for jobs in the union “shape up” is z 1 and those looking in the non-unionized sector is z 2.

© 2009 Pearson Education Canada 12/17 From Figure 12.4  20 jobs at the union wage of $12 are shared by all union members.  Assuming the jobs are shared equally, the proportion of time that any union member will be employed is 20/z 1  Assuming the jobs are shared equally, the proportion of time that any union member will be employed is 20/z 1 (jobs/union members).   The expected wage is the union wage ($12) times 20/z 1 or 240/z 1.

© 2009 Pearson Education Canada 12/18 Figure 12.5 Wage floors and search unemployment in a two-sector model

© 2009 Pearson Education Canada 12/19 From Figure 12.5  Figure 12.5 is different from 12.4 in that the expected wage rate is plotted in quadrant I.  Notice that the expected wage relationship passes point G in quadrant I because when 20 union workers look for jobs in the “shape up” each is employed full time at the union wage of $12 per hour.

© 2009 Pearson Education Canada 12/20 From Figure 12.5  Suppose the workers continue to join the union sector until the expected wage in the union sector equals that on the non-union sector.  Equilibrium allocation is at point C in quadrant III, with a wage of $8.

© 2009 Pearson Education Canada 12/21 From Figure 12.5  At equilibrium point C: –30 unionized workers are chasing 20 union jobs paying $12. –As unionized workers split available work equally, the expected wage is $240/30 = $8.

© 2009 Pearson Education Canada 12/22 From Figure 12.5  At equilibrium point C: –70 workers are employed in sector 2 –Unemployment equals u in quadrant I, (10 full time workers). –Note that in equilibrium in Figure 12.4 (point B in Figure 12.5), 80 non-union workers are employed in sector 2.

© 2009 Pearson Education Canada 12/23 From Figure 12.5  It is necessary that the equilibrium wage in sector two of the underemployment model is lower than that in the unemployment model. Why?  Because in the unemployment model, some non-union workers leave sector 2 to chase jobs in sector 1.  As a result, the smaller number of non- union workers remaining in sector 2 will earn a higher wage.

© 2009 Pearson Education Canada 12/24 From Figure 12.5:  Two sources of inefficiency arise in this model: 1. There is unemployment equal to u in quadrant I. 2. The allocation of workers who are employed is inefficient because the wage floor exceeds the equilibrium wage.

© 2009 Pearson Education Canada 12/25 Income Maintenance  What institution is best for transferring income to the poorer members of society? 1.Efficient transfer mechanism 2.Topping-up mechanism 3.Negative income tax

© 2009 Pearson Education Canada 12/26 Figure 12.6 An efficient income- transfer mechanism

© 2009 Pearson Education Canada 12/27 The Efficient Transfer Mechanism  Although the lump-sum mechanism is efficient, it is not practical.  There is no systematic way of choosing a target indifference curve or identifying individual preferences and budgets to pinpoint recipients.  As a result, policies are formulated in terms of income-maintenance mechanisms rather than utility-maintenance mechanisms.

© 2009 Pearson Education Canada 12/28 Income-Maintenance Programs  Income-maintenance programs have the objective of raising the income of anyone below a targeted level of income, up to that level.  In practical income-maintenance schemes, the amount of the income transfer is conditional upon the amount of the recipient’s earned income.

© 2009 Pearson Education Canada 12/29 Topping Up and Welfare  The essential feature of many welfare programs is a topping-up mechanism, where the subsidy is just large enough to put the recipient at the mandated income level.  The result is that potential recipients can affect the amount of income transferred to them by choosing how much income they earn.

© 2009 Pearson Education Canada 12/30 Topping Up and Welfare  If the potential recipient earns as much or more than the targeted income level (S’), he/she will not get any subsidy.  If he/she earns an income below S’, the amount of the subsidy will be just enough to raise total income to S’.  This topping-up mechanism translates into the kinked budget line in Figure 12.7.

© 2009 Pearson Education Canada 12/31 Topping Up and Welfare  This topping-up mechanism translates into the kinked budget line in Figure 12.7, which leads to inefficiency.  The inefficiency occurs because the recipient’s MRS at E, is less than the wage rate.

© 2009 Pearson Education Canada 12/32 Figure 12.7 An inefficient income-transfer mechanism

© 2009 Pearson Education Canada 12/33 The Negative Income Tax  The negative income tax (NIT) combines the elements of the efficient lump-sum transfer and the topping-up mechanism.  Though not problem-free, this combined scheme redistributes income to poorer members of society without the gross inefficiency and the perverse lack of work incentives associated with the welfare system.

© 2009 Pearson Education Canada 12/34 Figure 12.8 A negative income tax

© 2009 Pearson Education Canada 12/35 From Figure 12.8  This version of the NIT combines an unconditional income transfer for everyone (S’’) and a proportionate (yet moderate) income tax (t) on earned income.  Everyone receives the subsidy (S’’), pays twh in taxes, keeps (1-t)wh from his/her earned income, and receives net income equal to: x x 2 = S”+ (1-t)wh

© 2009 Pearson Education Canada 12/36 From Figure 12.8  At point E in Figure 12.8, the budget line is tangent to the indifference curve and the person is indifferent between the NIT and the topping-up mechanism.  This person works h* hours and earns income equal to wh*.

© 2009 Pearson Education Canada 12/37 From Figure 12.8  Point E is not an efficient equilibrium because the MRS is less than w.  The NIT offsets some of the inefficiencies associated with the topping-up mechanism and avoids the disincentive to work.  It also makes smaller demand on the public purse (DE for the NIT versus S’ for the topping-up mechanism).

© 2009 Pearson Education Canada 12/38 The Market for Superstars  Figure 12.9 shows two separate labour markets. There is a market demand and supply curve for talent levels of t=0.25 and the same for talent levels of t=0.35.  Consumers are willing to pay more for talented singers and we assume they can produce more CDs.

© 2009 Pearson Education Canada 12/39 Figure 12.9 Labour markets with different levels of talent

© 2009 Pearson Education Canada 12/40 The market for Superstars  A superstar market is characterized by a good or service that has a poor substitutability between quantity and quality.  Also a small number of individuals are able to supply the entire market.  More talented labour produces more CDs and gets a higher wage.