5.3 Interaction of labour markets

Wage differentials

Differences in wages/salary between individuals/occupations.

These exist because workers produce different marginal physical products. Wage differentials may also exist between locations.

Monopsony

A market in which there is a single buyer of a good, service or factor of production (labour)

Trade union

An organisation of workers that negotiates with employers on behalf of its members

Bilateral monopoly

A situation in which a monopoly seller of labour (a trade union) faces a monopsony buyer of labour (an employer)

Labour market flexibility

How responsive labour is to changes in demand and supply of labour.

Occupational labour market mobility

How easy it is for labour to move between different occupations

Geographical labour market mobility

How easy it is for labour to move between different regions

Equilibrium Wages in the Labour Market

-The equilibrium market wage rate is at the intersection of the supply and demand for labour.

-Employees are hired up to the point where the extra cost of hiring an employee (MCL) is equal to the extra sales revenue from selling their output (MRP)

Key Causes of Pay Differentials

Compensating wage differentials – a reward for risk-taking, working in poor conditions and during unsocial hours.

Reward for human capital – differentials compensate workers for (opportunity and direct) costs of human capital acquisition. 

Different skill levels – market demand for skilled labour (with inelastic supply) grows more quickly than for semi-skilled workers.

Differences in labour productivity and revenue creation - workers whose efficiency is highest and ability to generate revenue for a firm often rewarded with higher pay.

Trade unions who might use their collective bargaining power – to achieve a mark-up on wages compared to non-union members

Other barriers to labour supply e.g. professional exams

Employer discrimination - a factor that cannot be ignored despite over twenty years of equal pay legislation in place

Monopsony employers

-A monopsony occurs when there is a sole or a dominant employer in a labour market

-This means that the employer has buying power over their potential employees

-This gives them wage-setting power

-Monopsony is a potential cause of labour market failure

-For a monopsony, the supply curve of labour equals the average cost of labour

-The monopsony employer will have to bid up wages in order to attract new workers 

-But the wage they pay will not necessarily reflect the true marginal revenue product of people employed

Monopsony curve

-Profit maximising employment level is where MCL=MRPL e.g. E2 number of people are employed

-Their marginal revenue product is valued at W2

-But monopsony power of the employer allows them to pay wage rate W3

-In this sense, monopsony power can lead to exploitation of employed workers

Monopsony with National Minimum Wage

The new profit maximising level of employment with the minimum wage is now at E3 – which is a higher employment level and a higher wage than with the previous wage paid by the monopsony employer

Role of Trade Unions in the Labour Market

-Trade unions use collective bargaining with employers to protect their members

-Protecting and improving the real living standards / real wages of their members 

-Protecting workers against unfair dismissal (i.e. upholding employment rights)

-Promoting improvements in working conditions, work-life balance & related health and safety issues

-Promoting better workplace training and education, i.e. the accumulation of human capital

-Protection of pension rights for union members

-Security in employment 

Success of wage bargaining

-Unions will have more success in raising wages for their members if the demand for labour is relatively wage inelastic

-Unions also more influential when they represent a high % of all workers in a given industry/occupation

-Pay might also rise if unions and employers agree a pay deal based on success in lifting productivity

Policies to address labour market failure

Labour Immobility:

• Targeted employment subsidies / apprenticeships / internship opportunities

• Reforms to the housing market to improve affordability / lower travel costs

Disincentives to find / take work:

• Reforms to incomes taxes (lower rates) & benefit reforms (e.g. benefit cap)

• Increase in the national minimum wage / expansion of the living wage

Discrimination by employers:

• Tougher laws on equality and penalties for businesses flouting the law

• Laws on unfair dismissal / min wage + other measures to cut poverty pay

Monopsony power of employers:

• Encourage business start-ups  / small businesses as new employers

Minimum wage curve

-The free market equilibrium wage is W1 with employment level of E1

-If a minimum wage of W2 is introduced, then – other factors remaining the same – employment contracts to E2 and the supply of labour expands to E3

Advantages of a minimum wage

-Equity justification: Every job should given fair pay linked with skills/experience of an employee.

-Poverty reduction: A minimum wage boosts the take-home pay of thousands of lower paid workers

-Training: It encourages firms to up-skill their workers and can lead to higher labour productivity

-Incentives: Will improve incentives for people to look for paid work rather than stay on benefits

-Anti-discrimination: A way of tackling discrimination of low-paid female / younger workers

Disadvantages of a minimum wage

-Jobs: Higher minimum wage adds to the costs of employing workers and might cause higher unemployment

-Small businesses: Many smaller businesses struggle to make a profit - risk of a rise in business closures

-Training: There are better incentives for training than a minimum wage e.g. tax relief on apprenticeships

-Competitiveness: Might make many UK businesses less competitive in some global markets

-Inflation: Higher labour costs might cause higher inflation which then lowers real incomes for households