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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.