5. Wages and the Distribution of Income

Labour Market Trends Shift from agricultural and manufacturing to service-sector employment

Employment in different sectors of the UK economy

Labour Market Trends Shift from agricultural and manufacturing to service-sector employment Rise in part-time employment Shift from agricultural and manufacturing to service-sector employment Rise in part-time employment

Labour Market Trends Shift from agricultural and manufacturing to service-sector employment Rise in part-time employment Rise in female participation rates Shift from agricultural and manufacturing to service-sector employment Rise in part-time employment Rise in female participation rates

Labour Market Trends Shift from agricultural and manufacturing to service-sector employment Rise in part-time employment Rise in female participation rates Rise in temporary employment Shift from agricultural and manufacturing to service-sector employment Rise in part-time employment Rise in female participation rates Rise in temporary employment

Labour Market Trends Shift from agricultural and manufacturing to service-sector employment Rise in part-time employment Rise in female participation rates Rise in temporary employment Downsizing Shift from agricultural and manufacturing to service-sector employment Rise in part-time employment Rise in female participation rates Rise in temporary employment Downsizing

Wage Determination in a Perfect Market Perfect labour markets –everyone is a wage taker –freedom of entry –perfect knowledge –homogeneous labour Market equilibrium Perfect labour markets –everyone is a wage taker –freedom of entry –perfect knowledge –homogeneous labour Market equilibrium

S all workers in the market D all firms in the market O Labour hours Hourly wage WmWm A labour market: whole market

D individual employer O Labour hours Hourly wage Q1Q1 WmWm S labour A labour market: individual employer

O Labour hours Hourly wage Q2Q2 WmWm D labour S individual worker A labour market: individual worker

Wage Determination in a Perfect Market The supply of labour –why upward sloping –the position of the supply curve the number of qualified people non-wage benefits desirability of alternative jobs Elasticity of supply of labour –the mobility of labour The supply of labour –why upward sloping –the position of the supply curve the number of qualified people non-wage benefits desirability of alternative jobs Elasticity of supply of labour –the mobility of labour

Wage Determination in a Perfect Market The demand for labour: marginal productivity theory –the profit-maximising approach –the marginal cost of labour (MC L ) –the marginal revenue product of labour (MRP L ) The demand for labour: marginal productivity theory –the profit-maximising approach –the marginal cost of labour (MC L ) –the marginal revenue product of labour (MRP L )

O Q of labour Output MPP L x Marginal physical product of labour curve Diminishing returns set in here

Wage Determination in a Perfect Market The demand for labour: marginal productivity theory –the profit-maximising approach –the marginal cost of labour (MC L ) –the marginal revenue product of labour (MRP L ) –the profit-maximising level of employment for a firm The demand for labour: marginal productivity theory –the profit-maximising approach –the marginal cost of labour (MC L ) –the marginal revenue product of labour (MRP L ) –the profit-maximising level of employment for a firm

O £ WmWm MC L = W QeQe Q of labour MRP L The profit-maximising level of employment MRP L = MPP L × P good

Wage Determination in a Perfect Market The demand for labour: marginal productivity theory –the profit-maximising approach –the marginal cost of labour (MC L ) –the marginal revenue product of labour (MRP L ) –the profit-maximising level of employment for a firm –derivation of the firm’s demand curve for labour The demand for labour: marginal productivity theory –the profit-maximising approach –the marginal cost of labour (MC L ) –the marginal revenue product of labour (MRP L ) –the profit-maximising level of employment for a firm –derivation of the firm’s demand curve for labour

O Q of labour £ MRP L W1W1 MC L 1 Q1Q1 MC L 2 W2W2 MC L 3 W3W3 Q2Q2 Q3Q3 a b c Deriving the firm’s demand curve for labour Profits maximised where MRP L = MC L

D O Q of labour £ W1W1 MC L 1 Q1Q1 MC L 2 W2W2 MC L 3 W3W3 Q2Q2 Q3Q3 a c Deriving the firm’s demand curve for labour The MRP L curve traces out the demand curve b

Wage Determination in a Perfect Market Wages and profits under perfect competition

O MC L = W Surplus for firm Wages W QeQe Q of labour £ MRP L Wages and profits

Wage Determination in a Perfect Market Power in labour markets Firms with monopsony power in employing labour –MC L > W Power in labour markets Firms with monopsony power in employing labour –MC L > W

O Q of labour £ MRP L AC L  W (supply curve) MC L Monopsony

Wage Determination in a Perfect Market Power in labour markets Firms with monopsony power in employing labour –MC L > W –effects on wages and employment Power in labour markets Firms with monopsony power in employing labour –MC L > W –effects on wages and employment

O Q of labour £ MRP L AC L  W (supply curve) Q1Q1 MC L Monopsony W1W1 Q2Q2 W2W2

Wage Determination in Imperfect Markets Power in labour markets Firms with monopsony power in employing labour –MC L > W –effects on wages and employment Unions with monopoly power Power in labour markets Firms with monopsony power in employing labour –MC L > W –effects on wages and employment Unions with monopoly power

Wage Determination in Imperfect Markets Power in labour markets Firms with monopsony power in employing labour –MC L > W –effects on wages and employment Unions with monopoly power –unions facing competitive employers Power in labour markets Firms with monopsony power in employing labour –MC L > W –effects on wages and employment Unions with monopoly power –unions facing competitive employers

Power in labour markets Firms with monopsony power in employing labour –MC L > W –effects on wages and employment Unions with monopoly power –unions facing competitive employers –effects of wage increases on employment Power in labour markets Firms with monopsony power in employing labour –MC L > W –effects on wages and employment Unions with monopoly power –unions facing competitive employers –effects of wage increases on employment Wage Determination in Imperfect Markets

O Q of labour Q1Q1 W1W1 S D £ W2W2 Q2Q2 Q3Q3 Monopoly union facing producers under perfect competition Monopoly union facing producers under perfect competition Unemployment

Bilateral monopoly –no unique equilibrium –relationship between wages and employment Bilateral monopoly –no unique equilibrium –relationship between wages and employment Wage Determination in Imperfect Markets

O Q of labour £ W1W1 Q1Q1 MRP L MC L 1 No union S 1 (=AC L 1 ) No union Bilateral monopoly Monopsony: no union

W2W2 x MC L 2 = AC L 2 O Q of labour £ W1W1 Q1Q1 MRP L MC L 1 No union S 1 (=AC L 1 ) No union Bilateral monopoly Bilateral monopoly Q3Q3

W2W2 x MC L 2 = AC L 2 O Q of labour £ W1W1 Q1Q1 MRP L MC L 1 Bilateral monopoly Wage can rise to W 2 with no fall in employment

W2W2 x MC L 3 = AC L 3 O Q of labour £ W1W1 Q1Q1 MRP L MC L 1 Bilateral monopoly Wage can rise from W 1 to W 3 and employment rises to Q 2 W3W3 Q2Q2

Bilateral monopoly –no unique equilibrium –relationship between wages and employment –collective bargaining Bilateral monopoly –no unique equilibrium –relationship between wages and employment –collective bargaining Wage Determination in Imperfect Markets

Bilateral monopoly –no unique equilibrium –relationship between wages and employment –collective bargaining union threats and promises Bilateral monopoly –no unique equilibrium –relationship between wages and employment –collective bargaining union threats and promises Wage Determination in Imperfect Markets

Bilateral monopoly –no unique equilibrium –relationship between wages and employment –collective bargaining union threats and promises employers’ threats and promises Bilateral monopoly –no unique equilibrium –relationship between wages and employment –collective bargaining union threats and promises employers’ threats and promises Wage Determination in Imperfect Markets

Bilateral monopoly –no unique equilibrium –relationship between wages and employment –collective bargaining union threats and promises employers’ threats and promises role of the government Bilateral monopoly –no unique equilibrium –relationship between wages and employment –collective bargaining union threats and promises employers’ threats and promises role of the government Wage Determination in Imperfect Markets

The efficiency wage hypothesis –higher wage rates may lead to higher productivity less “shirking” reduced labour turnover self-selection morale The efficiency wage hypothesis –higher wage rates may lead to higher productivity less “shirking” reduced labour turnover self-selection morale Wage Determination in Imperfect Markets

Flexible labour markets –the flexible firm –functional flexibility –numerical flexibility –core workers –peripheral workers Flexible labour markets –the flexible firm –functional flexibility –numerical flexibility –core workers –peripheral workers Wage Determination in Imperfect Markets

Core group Primary labour marketFunctionalflexibility Core group Primary labour marketFunctionalflexibility The flexible firm

First peripheral group Secondary labour market Numerical flexibility First peripheral group Secondary labour market Numerical flexibility Core group Primary labour marketFunctionalflexibility Core group Primary labour marketFunctionalflexibility The flexible firm

First peripheral group Secondary labour market Numerical flexibility First peripheral group Secondary labour market Numerical flexibility Self-employment Core group Primary labour marketFunctionalflexibility Core group Primary labour marketFunctionalflexibility The flexible firm

First peripheral group Secondary labour market Numerical flexibility Self-employment Core group Primary labour marketFunctionalflexibility Agencytemporaries The flexible firm

First peripheral group Secondary labour market Numerical flexibility Self-employment Core group Primary labour marketFunctionalflexibility Agencytemporaries Sub-contracting The flexible firm

First peripheral group Secondary labour market Numerical flexibility Self-employment Increasedoutsourcing Core group Primary labour marketFunctionalflexibility Agencytemporaries Sub-contracting The flexible firm

First peripheral group Secondary labour market Numerical flexibility Second peripheral group Self-employment Increasedoutsourcing Core group Primary labour marketFunctionalflexibility Agencytemporaries Sub-contracting The flexible firm

First peripheral group Secondary labour market Numerical flexibility Short-termcontracts Second peripheral group Self-employment Increasedoutsourcing Core group Primary labour marketFunctionalflexibility Agencytemporaries Sub-contracting The flexible firm

First peripheral group Secondary labour market Numerical flexibility Short-termcontracts PublicSubsidyTrainees Second peripheral group Self-employment Increasedoutsourcing Core group Primary labour marketFunctionalflexibility Agencytemporaries Sub-contracting The flexible firm

First peripheral group Secondary labour market Numerical flexibility Short-termcontracts PublicSubsidyTrainees Delayedrecruitment Second peripheral group Self-employment Increasedoutsourcing Core group Primary labour marketFunctionalflexibility Agencytemporaries Sub-contracting The flexible firm

First peripheral group Secondary labour market Numerical flexibility Short-termcontracts PublicSubsidyTrainees Delayedrecruitment Jobsharing Second peripheral group Self-employment Increasedoutsourcing Core group Primary labour marketFunctionalflexibility Agencytemporaries Sub-contracting The flexible firm

First peripheral group Secondary labour market Numerical flexibility Short-termcontracts PublicSubsidyTrainees Delayedrecruitment Jobsharing Parttime Second peripheral group Self-employment Increasedoutsourcing Core group Primary labour marketFunctionalflexibility Agencytemporaries Sub-contracting The flexible firm

Flexible labour markets –the flexible firm –functional flexibility –numerical flexibility –core workers –peripheral workers –Implications for the distribution of income Flexible labour markets –the flexible firm –functional flexibility –numerical flexibility –core workers –peripheral workers –Implications for the distribution of income Wage Determination in Imperfect Markets

Causes of Inequality Inequality in the UK –income distribution before and after taxes and benefits Inequality in the UK –income distribution before and after taxes and benefits

Size distribution of UK income by quintile group of households: 1998/9 Size distribution of UK income by quintile group of households: 1998/9 Bottom 20% Next 20% Middle 20% Next 20% Top 20% 15% 25% 52% 7% 3% Income before taxes and benefits

Size distribution of UK income by quintile group of households: 1998/9 Size distribution of UK income by quintile group of households: 1998/9 Bottom 20% Next 20% Middle 20% Next 20% Top 20% 15% 25% 52% 7% 3% Bottom 20% Next 20% Middle 20% Next 20% Top 20% 11% 16% 22% 45% 7% Income before taxes and benefits Income after taxes and benefits

Causes of Inequality Inequality in the UK –income distribution before and after taxes and benefits –distribution of income by source Inequality in the UK –income distribution before and after taxes and benefits –distribution of income by source

Sources of UK household income as a percentage of gross household income Sources of UK household income as a percentage of gross household income /9 67% 8% 4% 7% 13% 1%1% 1%1% 77% 7% 4% 3% 9% Wages and salaries Income from self employment Investment income Pensions, annuitiesSocial security benefits Other Source: Family Spending (ONS, 2000)

Causes of Inequality Inequality in the UK –income distribution before and after taxes and benefits –distribution of income by source –distribution of wages and salaries by occupation Inequality in the UK –income distribution before and after taxes and benefits –distribution of income by source –distribution of wages and salaries by occupation

Average gross weekly earnings of UK full-time adult employees: 1999

Causes of Inequality Inequality in the UK –income distribution before and after taxes and benefits –distribution of income by source –distribution of wages and salaries by occupation –distribution of wages and salaries by sex Inequality in the UK –income distribution before and after taxes and benefits –distribution of income by source –distribution of wages and salaries by occupation –distribution of wages and salaries by sex

Average gross weekly earnings of UK full-time adult employees: 1999

Average gross hourly earnings for full-time adult UK employees (pence per hour):

Average gross hourly earnings for full-time UK employees on adult rates (1999)

Causes of Inequality The causes of inequality –differences in ability –differences in attitude –differences in qualifications –differences in hours worked –differences in pleasantness of job –differences in power –differences in the demand for goods –discrimination –differences in household composition The causes of inequality –differences in ability –differences in attitude –differences in qualifications –differences in hours worked –differences in pleasantness of job –differences in power –differences in the demand for goods –discrimination –differences in household composition

Weekly income for different types of UK household: 1998/9 Source: Family spending (ONS,2000) One adult (not retired) One adult, two or more children One man, one woman (not retired) Two adults, four or more children

Causes of Inequality The causes of inequality (cont.) –inequality of wealth –degree of government support –unemployment The causes of inequality (cont.) –inequality of wealth –degree of government support –unemployment

The Redistribution of Income Taxation –tax and income proportional progressive regressive –problems in using taxes to redistribute incomes income taxes taxes on goods and services Taxation –tax and income proportional progressive regressive –problems in using taxes to redistribute incomes income taxes taxes on goods and services

The Redistribution of Income Taxation (cont.) –taxation and incentives income and substitution effects raising the higher rates of tax raising the basic rate reducing tax allowances Taxation (cont.) –taxation and incentives income and substitution effects raising the higher rates of tax raising the basic rate reducing tax allowances

The Redistribution of Income Benefits –cash benefits means-tested benefits universal benefits –benefits in kind –benefits and the redistribution of income Benefits –cash benefits means-tested benefits universal benefits –benefits in kind –benefits and the redistribution of income

Social protection benefits in various European countries: (a) Euro per head Source: Eurostat, 2000 Euro per head

Social protection benefits in various European countries: (b) % of GDP Source: Eurostat, 2000 % of GDP

The Redistribution of Income Benefits –cash benefits means-tested benefits universal benefits –benefits in kind –benefits and the redistribution of income –the problem of the poverty trap Benefits –cash benefits means-tested benefits universal benefits –benefits in kind –benefits and the redistribution of income –the problem of the poverty trap