Wage Determination in Competitive Labor Markets

1. Labor Markets The Human Input

2. Wage Determination in Competitive Markets • Wages=price of labor • In a free labor market, wages would be determined by supply and demand • Labor markets, however, have distinctive features • The firm workers until the point where MRPL=P (of labor, or wage)

3. The Demand for Labor and the Determination of Wages • Marginal revenue product of labor=MRPL=the increase in the employer’s total revenue that results when it hires an additional unit of labor • MRPL slopes downward (Law of diminishing returns) • Demand for labor is the same as the MRPL

4. Equilibrium in a Competitive Labor Market This assumes that there is no interference (I.e. minimum wage or unions) Total income of workers= Pe x Qe

5. Shifts in the Demand for Labor • Increased education • Investment in human capital—spending on increased education and on other means to increase the knowledge and skills of the labor force • On the job training • Anything that improves the market for the goods and the services that the labor is producing

6. Shifts in the demand for labor—Technical Change and Productivity Growth • The quality and quantity of other inputs effects the MRPL. • Machinery, power sources, etc. can add to the amount that can be produced by a given amount of labor (the MPPL or marginal physical product) • MRP = MPP x P • A rise in the Marginal Physical Product results in a greater supply, and a lower equilibrium price. Therefore, we can’t know the net effect on MRP

8. Supply of Labor • Rightward shifts due to growth of population (birth and immigration), rise in labor force participation (women, etc. entering the workforce • Increase in supply of labor tends to depress wages

9. Supply of Labor • Given the fixed amount of a time in a week, a person’s decision to supply labor to firms is simultaneously a decision to demand leisure time for himself. • If there are 24 hours a day, a decision to spend 8 hours working is also a decision to spend 16 hours doing other things

10. Supply of Labor • Substitution effect: When wages increase, there is a resulting incentive to work more because of the higher relative reward to labor compared to leisure • Income effect: The resulting rise of worker’s purchasing power after a rise in wages that enables to afford more leisure • Therefore… a wage increase will cause some people to work more and some people to work less. Still other people won’t change their habits. • Lets look at a graph!

11. Supply of Labor • For low-wage workers, the substitution effect is important. They will work more when wages rise. • Most workers won’t change their labor patterns following a rise in wages. • For high wage workers, the income effect outweighs substitution effects. They tend to work less when wages rise The supply curve of labor is said to be backward bending when a small rise in wages leads to a rise in quantity of labor supplied but a large wage rise reduces the amount of labor supplied

12. Why Do Wages Differ? • Demand can be different—each workers MPP depends on their abilities and degree of effort • Supply—Size of available working populace. Immigration may depress wages, because working populace increases in size. • Supply--Nonmonetary attractiveness of job influences supply (Working at Myers Park is alright, working at West Charlotte is scary) • Supply—Amount of training. (Lots of people can be janitors. Not many people can be heart surgeons).

13. Rent Component of Wages • Economic rent is any portion of the payment to labor or any other input that does not lead to an increase in the amount of labor supplied • Result of abilities and skills that cannot be duplicated easily • Example: salaries of professional athletes. Most people couldn’t be professional athletes, even if they trained their whole lives.

14. Investment in Human Capital • Why are you in high school instead of working a job? • Wages of doctors and lawyers are the return on their (educational) investment • Human capital theory focuses on the expenditures that have been made to increase the productive capacity of workers via education or other means similar to investment in machines to increase productivity

15. Why do jobs with higher educational requirements pay higher wages? • Because educated workers are more productive….right? Well maybe. • Other possibilities • Education as a sorting mechanism • Dual Labor Market Theory

16. Theory One: Education as a Sorting Mechanism • People differ in ability when the enter the school system ad differ in more or less the same ways when they leave • Educational system (grades, level of education achieved, etc.) sorts individuals by motivation, intelligence, etc.

17. Theory Two: Theory of Dual Labor Markets • Emphasizes that labor is supplied in two types of market, one with high wages and promising opportunities and the other with low wages and dead-end jobs • The educational system helps decide which individuals end up in which market • For those in the “primary labor market” (where the good jobs are), education really is productive, does result in higher wages

19. Unions and Collective Bargaining • A labor union is an organization made up of a group of workers (usually with the same specialization or in the same industry) • The union represents the workers in negotiations over issues such as wages, vacations, and sick leave

20. Unionism in America • 16 million U.S. workers—12.5% of wage and salary workers—belong to unions • 9 million belong to the AFL-CIO or affiliated unions • 7 million belong to independent unions • Decline over time—but why?

21. Decline in Unionism • Structural-change hypothesis: theory that changes unfavorable to expansion of union membership have occurred in economy and labor force. People shifting away from unionized industries • Managerial-opposition hypothesis: theory that decline has occurred because of intensified managerial opposition to union growth. The wage advantage of union workers causes union firms to be less profitable than nonunion firms. Therefore, management pursues policies to decrease unions

22. Business Unionism • In the United States, unions generally have adhered to a philosophy of business unionism: unionism that is concerned with short-run economic objectives of higher pay, better benefits, shorter hours, and improved working conditions • Doesn’t try to overthrow or significantly modifying capitalist system

23. Union As Labor Monopolies • Before this, we have been analyzing the labor market as the sum of individuals decisions • Union=monopoly seller of labor • Faces a demand curve, and can choose the point on the curve that sees best. • So where on the curve are they going to pick?

24. Alternative Union Goals • They could decide the size of the union is fixed and try to force employers to pay the highest wage they will pay without firing anyone • They could try to make the union really big (at a lower wage) • They could try to maximize the total earnings of all workers taken together (balance between employment and wages) • Tradeoff—increase in wages tends to lead to a decrease in employment

25. Ideal Situation for a Union • Best case scenario for a union—achieve wage gains without sacrificing employments • Featherbedding—forcing management to employ more workers than it really needs • Increasing demand for the industry’s product

26. Monopsony and Bilateral Monopoly • Things aren’t always so simple… • Monopsony—A market situation in which there is only one buyer. The firm is the only party purchasing the union’s labor • Bilateral monopoly—A market sitaution in which there is both a monopoly on the selling side and on the buying side

27. Monopsony • One buyer of labor • Labor is relatively unable to work elsewhere. • Key component: upward sloping supply of labor (same as market) • Results in breakaway MRC curve

28. Monopsony Graph MRC S MRC = MRP S = ATC of Labor Wc Competitive Market Wm MRP = D Qm Qc

29. Collective Bargaining • Collective Bargaining: The process of negotiation of wages and working conditions between a union and the firms in an industry • Mediation: A neutral individual helps the parties reach an agreement • Arbitration: A neutral party helps the parties with the power to decide, both parties must accept his decision And if it doesn’t work?

30. Strike! • Most collective bargaining doesn’t lead to strikes • “work stoppage” by union if it thinks its demands are not being met • Lockout—forbids the workers to return to work until a new contract is signed

31. Economic Effects of Unions: Union Wage Advantage -Empirical research suggests unions do raise the wages of their members relative to nonunion workers -May also raise wages of nonunion workers by forcing nonunion employers to compete more fiercely for workers

32. The “shock effect”—higher wages cause them to implement productivity increasing technologies Reduced worker turnover Voice mechanism—gives workers the ability to communicate with employer, instead of just quitting Increase informal trainingunion insistence on seniority Losses via featherbedding and work rules—engaging in “make-work” practices and resisting the introduction of output increasing machinery Losses via strikes—the firm forgoes sales and profit, firm’s production ceases for strikes duration Losses via labor misallocation Economic Effects of Unions: The Good and the Bad

33. Labor Market Discrimination • Occurs when equivalent labor resources are paid or treated different even though their productive contributions are equal • Wage discrimination—a group (frequently women or minorities) are paid less for the same type of work • Employment discrimination—a group receives inferior treatment in hiring, promotions, etc. • Occupational discrimination—a group is arbitrarily restricted from entering more desirable occupations “glass ceiling” • Human Capital Discrimination—a group doesn’t have the same access to productivity enhancing investments

34. Why Even Mr. W Should Care About Discrimination • It’s bad for the economy and inefficient