Labour Markets

Labour Supply

In order to apply an economic model to the decision on how much labour to supply, we just imagine that we have two options with how we spend our time

1. Spend Time Earning Money (Working)

2. Spend Time Enjoying Leisure 

Therefore, we return to the idea of Indifference Analysis to show preferences for working and leisure First of all, we have something that looks like our budget constraint, only here the constraint is on time, not money

Factor Market - Wage Determination

a worker whose utility is defined as a function of leisure and weekly income. An indifference map and budget line (the slope of which is determined by the hourly wage) may be drawn…

a decline in the wage leads to a change in leisure demand, and also a change in labour supply

the change can be divided into an income effect and a substitution effect

the substitution effect of a wage change on labour supply is always positive, the income effect of a wage change on labour supply may be positive or negative

Labour Demand

• Recall the law of diminishing marginal product which shows how, eventually, the addition to output generated by the last unit of a factor (e.g. labour) employed declines

• Multiplying the marginal product of labour (MPL) by output price gives the marginal value product of labour (MVPL). Recall that in a perfectly competitive product market, the price is given

• In a perfectly competitive labour market, the wage is the marginal cost of labour, and each firm treats it as given

• The perfectly competitive, profit maximising firm will employ workers up to the point where w=MVPL

• In a perfectly competitive labour market, the wage is the marginal cost of labour, and is given

• The worker’s attractiveness to the employer depends not only on how many units of goods she produces, but also on the price of the good and on the wage rate

• The MVPL is therefore the labour demand curve of a perfectly competitive profit maximising firm

Monopoly Power

• If the firm has monopoly power in the product market, the MPL should be multiplied by the MR (not price) to give the labour demand curve (the marginal revenue product of labour). The MRP is left of the MVP. Since a monopoly produces less output than a competitive firm, it will also employ fewer workers

• Notice: The firm is still in perfect competition in the labour market so the wage and MCL are still given

Monopsony Power

• If the firm has monopsony power in the labour market, the MCL will be upward sloping. Profit maximisation occurs where MCL=MRP, but wage is determined by the average cost of labour (= labour supply)

• Firms gain monopsony power when workers are not constantly searching for alternative employment

Minimum Wages

• In a standard model, a minimum wage can generate an excess supply of labour – that is, unemployment

• But in a monopsony, a minimum wage can raise employment

• Once the minimum wage is imposed, the MCL becomes the minimum wage (up to the point where ACL passes above it)

Explaining Differences in Earnings

• Differences in pay reflect differences in the corresponding marginal value product of labour

• But even if people appear equally talented and hard-working, we may observe differences in their incomes

The Human Capital Explanation

Human capital theory: a theory of pay determination that says a worker’s wage will be proportional to his or her stock of human capital. Human capital is an amalgam of factors such as education, training, experience, intelligence, energy, work habits, trustworthiness and initiative that affect the value of a worker’s marginal product.

Trades Unions

Two workers with the same amount of human capital may earn different wages if one of them belongs to a labour union, that is, a group of workers who bargain collectively with employers for better wages and working conditions.

Compensating Wage Differential

• Other things being equal, we expect that jobs with attractive working conditions will pay less than jobs with poor conditions. Wage differences associated with differences in working conditions are known as compensating wage differentials. 

• Compensating wage differential: A difference in the wage rate – negative or positive – that reflects the attractiveness of a job’s working conditions.

Discrimination by Employers

Employer discrimination refers to wage differentials reflecting an arbitrary preference by an employer for one group of workers over another.

Discrimination by Others

Customer discrimination: the willingness of consumers to pay more for a product produced by members of a favoured group, even if the quality of the product is unaffected. 

Winner-Takes-All Markets

Difference in human capital do much to explain observed differences in earnings. Yet earnings differentials have also grown sharply in many occupations within which the distribution of human capital among workers seems essentially unchanged.

Gini Coefficient

A measure of equality of distribution of income or wealth by percentages of households or individuals from poorest to richest. It provides a basis for comparing distributions on a objective numerical basis.