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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
INTRODUCTION - THE LABOUR MARKET
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 middleranking 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.
The costs and benefits of formal education
S
U
L
0
Direct cost
of education
L+T
Net cost of education
Consumer satisfaction
Age
The costs and benefits of formal education
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.
Economic Discrimination
DE
D0
Quantity of labour
[i]. Elite market [E]
Quantity of labour
[ii]. Ordinary market [O]
Economic Discrimination
S0
DE
D0
SE
E0
E0
w0
w0
q1
q0
Quantity of labour
[i]. Elite market [E]
q0
Quantity of labour
[ii]. Ordinary market [O]
Economic Discrimination
S0
S’E
DE
E1
S’0
D0
SE
E0
w1
E0
w0
E1
w0
w2
q1
q0
Quantity of labour
[i]. Elite market [E]
q0
q2
Quantity of labour
[ii]. Ordinary market [O]
Economic discrimination, (i) elite market
Market E requires above-average skills.When there is no
discrimination, demand and supply are DE and SE.
Initially the wage rate is w0 and employment is q0.
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 w1.
Economic discrimination, (ii) ordinary market
Market O requires only ordinary skills. When there is no
discrimination, demands and supplies are D0 and S0.
Initially the wage rate is w0 and employment is q0.
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 w2 .
Because all Ys are forced into the O occupations, their wage is
lower than the wages earned in the E market.
Figure 15.4 A Monopsonist Facing Many Sellers
MC
S
Em
wc
wm
D = MRP
qm
qc
Quantity of labour
A monopsonist facing many sellers
The competitive wage and employment are wc, and qc.
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 Em.
The firm hires qm workers at a wage of wm,. Labour’s income is
shown by the dark yellow and dark blue areas enclosed by qm, and
wm.
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 qc 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 wm, and
wc and the dark yellow area between wm and the S curve. (Under
perfect competition both yellow areas are parts of labour’s
income.)
A Single Union Facing Many Employers
S
D
E1
x
w1
E0
w0
q1
q0
q2
Quantity of labour
A Single Union Facing Many Employers
Competitive equilibrium is at E0.
The union sets the wage at w1.
This creates a perfectly elastic supply curve of labour up to the
quantity q2 which is the amount of labour willing to work at the
wage w1.
Equilibrium is at E1 with q1 workers employed and q2 – q1 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 a Single Employer
MC
S
wu
x
E0
w0
wm
MRP = D
qm
Quantity of Labour
q0
q2
A Single Union Facing a Single Employer
The monopsonist facing competitively supplied labour is in the
equilibrium with qm, workers employed at a wage of wm,.
If a newly entering union sets its wage at w0, the supply curve runs
from w0 to E0 and then rises along the line S.
Equilibrium is at E0 with employment at q0.
If the union seeks a wage higher than w0, it must accept a lower
level of employment than q0.
The union can, for example, set a wage at wu, creating a supply
curve that runs from wu to x then up the S curve.
A Single Union Facing a Single Employer
This yields the same level of employment, qm, as when the
monopsonist dominated the market.
But the wage of wu is much higher.
At that wage rate there are q2 - qm people who would like to work
but who are unable to find employment.