The Labour Market Chapter 11 LIPSEY & CHRYSTAL ECONOMICS 12e

Learning Outcomes Some long-lasting wage differentials arise from differences in skills and educational attainments, and some arise from differences in age and gender. The full characteristics of many of today’s workers are hard to ascertain in advance, so labour market practices evolve to cope with imperfect and asymmetric information.

Learning Outcomes Some wage differentials arise from the type of market in which labour is sold; different wages are likely to be produced by competitive markets, where there are many buyers and sellers. In monopoly markets, in which unions control the supply, and in markets in which there are so few employers that each has power to influence the outcome.

Learning Outcomes Efficiency wages are above the minimum that would be required to hire a worker as they contain an incentive for the employee to perform well Selection and management procedures evolve to provide effective monitoring and incentive mechanisms Internal labour markets within firms are like tournaments in which employees compete for promotion to more senior and better paid jobs

Wage Differentials Equilibrium wage differentials can arise among jobs because [a] each requires different degrees of physical or mental abilities, [b] each requires different amounts of human capital acquired through costly formal education or on-the-job training, [c] some jobs are closed to people who could fill them as a result of discrimination, and [d] the factor markets related to different jobs have different competitive structures. INTRODUCTION - THE LABOUR MARKET

Wage Differentials In perfectly competitive factor markets, wages are set by demand and supply and there is no unemployment in equilibrium. In monopolistic markets, wages and employment are less than their competitive levels, but there is no unemployment in equilibrium. INTRODUCTION - THE LABOUR MARKET

If a union enters a perfectly competitive market, it can raise wages above the competitive level at the cost of lowering employment and creating a pool of persons who would like to work at the union wage but cannot. If a union enters a monopsonistic labour market, it can raise wages and employment to the competitive level. INTRODUCTION - THE LABOUR MARKET

If it raises wages beyond that point, employment will fall. Unions and professional associations can sometimes restrict the supply of labour and thereby achieve wages above the competitive equilibrium without creating a pool of unemployed. INTRODUCTION - THE LABOUR MARKET

Minimum-wage laws have a similar effect to the setting of wages by unions. If the market was monopsonistic before the minimum wage is imposed, wages and employment can be raised. If it was competitive, wages can be raised only at the expense of some (possibly small) reduction in employment in the affected occupation. INTRODUCTION - THE LABOUR MARKET

Heterogeneity, Incentives, and Monitoring Costs Today’s labour markets are complicated by the fact that brainpower is extremely heterogeneous but it is hard for employers to discern the full characteristics of individual workers. Many employment contracts are relational contracts, which do not specify in detail what workers have to do. INTRODUCTION - THE LABOUR MARKET

Heterogeneity, Incentives, and Monitoring Costs This creates the potential for principal-agent problems, where the hired employees act, in part, in their own interest rather than that of the employer. Solutions to the principal-agent problem involve some combination of incentives and monitoring. INTRODUCTION - THE LABOUR MARKET

Most skilled, managerial, and professional workers now find themselves in an internal labour market that has some of the characteristics of a tournament. Here the main incentive for lower - and middle- ranking staff is to achieve promotion. Higher pay generally attaches to more senior jobs, and the competition to gain promotion can be thought of as a tournament. INTRODUCTION - THE LABOUR MARKET

The costs and benefits of formal education S U Age L + T L Net cost of education Consumer satisfaction Direct cost of education 0 Income earned

 Acquiring human capital through formal education beyond minimum school-leaving age implies costs now and benefits later.  Age is plotted on the horizontal axis and income earned on the vertical axis.  Income is zero until age L, which is the minimum school-leaving age.  After that the yellow line, U, shows the income of a typical person who leaves school at age L and takes the relatively unskilled job.  The blue line, S, shows the more complicated stream of payments and income receipts of someone who stays on for T years of formal training after age L.  At first receipts are negative, reflecting the net out-of -pocket expenses related to attending school and university. The costs and benefits of formal education

 Deducting the consumption value placed on being at school rather than at work (light yellow area) yields the net cost associated with being in school.  Adding this to the income that could have been earned by going directly into the labour force at age L yields the total cost of the education, which is the medium yellow area.  The benefit is shown by the dark yellow area, representing the difference between the income earned in the skilled lob that is acquired at year L + T (line S) and the income that would have been earned if the labour force had been entered at age L (line U). The costs and benefits of formal education

 The investment in human capital could not possibly be worthwhile unless the dark yellow benefit area exceeded the medium yellow cost area.  The net benefit to a particular individual depends on how much he or she discounts the future gain in order to compare it with the immediate costs. The costs and benefits of formal education

Economic Discrimination DEDE D0D0 Wage rate Quantity of labour [i]. Elite market [E] [ii]. Ordinary market [O] Quantity of labour

DEDE D0D0 S0S0 E0E0 SESE E0E0 q1q1 Wage rate Quantity of labour q0q0 q0q0 w0w0 w0w0 [i]. Elite market [E] [ii]. Ordinary market [O] Wage rate Economic Discrimination

DEDE D0D0 S0S0 S’ 0 E1E1 E0E0 E1E1 S’ E SESE E0E0 Quantity of labour q1q1 Wage rate Quantity of labour q0q0 q2q2 q0q0 w0w0 w0w0 w2w2 w1w1 [i]. Elite market [E] [ii]. Ordinary market [O] Wage rate Economic Discrimination

Economic discrimination, (i) elite market  Market E requires above-average skills.When there is no discrimination, demand and supply are D E and S E.  Initially the wage rate is w 0 and employment is q 0.  Now let Y-type workers be barred from E occupations.  The supply curve shifts to S’ E and the wage earned by the remaining workers, all of whom are type X, rises to w 1.

Economic discrimination, (ii) ordinary market  Market O requires only ordinary skills. When there is no discrimination, demands and supplies are D 0 and S 0.  Initially the wage rate is w 0 and employment is q 0.  Now let type-Y workers be barred from E occupations.  The Y workers put out of work in the E market move to the O market, shifting its supply curve to S’ 0.  The wage earned by the workers in the O market falls to w 2.  Because all Ys are forced into the O occupations, their wage is lower than the wages earned in the E market.

MC S EmEm qmqm D = MRP qcqc wcwc wmwm Figure 15.4 A Monopsonist Facing Many Sellers Wage rate Quantity of labour

A monopsonist facing many sellers  The competitive wage and employment are w c, and q c.  The monopsonist who must pay the same wage to all equates the marginal cost of hiring labour with labour’s marginal revenue product, which occurs at point E m.  The firm hires q m workers at a wage of w m,. Labour’s income is shown by the dark yellow and dark blue areas enclosed by q m, and w m.  A perfectly discriminating monopsonist can pay each worker his or her supply price, so the S curve is also its marginal cost curve.

A monopsonist facing many sellers  The firm will hire q c and pay a total income equal to the dark and medium blue areas under the S curve.  The monoponist's profits are the light yellow area between w m, and w c and the dark yellow area between w m and the S curve. (Under perfect competition both yellow areas are parts of labour’s income.)

E0E0 D S E1E1 x q1q1 q0q0 q2q2 w1w1 w0w0 A Single Union Facing Many Employers Wage rate Quantity of labour

 Competitive equilibrium is at E 0.  The union sets the wage at w 1.  This creates a perfectly elastic supply curve of labour up to the quantity q 2 which is the amount of labour willing to work at the wage w 1.  Equilibrium is at E 1 with q 1 workers employed and q 2 – q 1 willing to work at the going wage rate but unable to find employment. Labour income is shown by the blue area. A Single Union Facing Many Employers

E0E0 MRP = D S MC wuwu w0w0 wmwm qmqm q0q0 q2q2 Wage rate Quantity of Labour A Single Union Facing a Single Employer x

 The monopsonist facing competitively supplied labour is in the equilibrium with q m, workers employed at a wage of w m,.  If a newly entering union sets its wage at w 0, the supply curve runs from w 0 to E 0 and then rises along the line S.  Equilibrium is at E 0 with employment at q 0.  If the union seeks a wage higher than w 0, it must accept a lower level of employment than q 0.  The union can, for example, set a wage at w u, creating a supply curve that runs from w u to x then up the S curve. A Single Union Facing a Single Employer

 This yields the same level of employment, q m, as when the monopsonist dominated the market.  But the wage of w u is much higher.  At that wage rate there are q 2 - q m people who would like to work but who are unable to find employment. A Single Union Facing a Single Employer