3.5.3 Wage determination in competitive and non-competitive markets

Wage Determination in a competitive market

Assumptions:

  • Homogenous labour

  • Perfect information for both labour and firms

  • Many potential workers

  • No barriers to entry or exit

  • Firms are wage takers

  • In a perfectly competitive market there would be no wage differentials as it is assumed that workers are homogenous and there is no immobility of labour

Labour market equilibrium

In the above diagram the labour market equilibrium is shown in a perfectly competitive market as well as the individual firm in that market. As labour market is perfectly competitive, the firm is a wage taker and therefore they have to take the wage in which the labour market sets. The demand for labour and the supply of labour dictate the labour market equilibrium. This gives a wage of W1 for workers within the given occupation and a quantity of Q1. The individual firm takes this wage rate and hires up to the point where MRP is equal to MCL, giving a quantity level of Q1. As shown on the diagram, the shape of the marginal revenue product curve is based upon the theory of diminishing marginal productivity. 

Why do wage differentials occur?

  • Labour is not homogenous i.e. differing MRP, discrimination

  • Non monetary considerations when taking a job i.e. holidays, pension schemes

  • Labour is not perfectly mobile i.e. occupational and geographical immobility - lack of perfect knowledge

  • Trade unions and supply restrictions - collective bargaining - distorts perfectly competitive market outcomes

  • Monopsony and wage setting power

Non Competitive markets:

  • Monopsony employers

  • Barriers to entry

  • Asymmetric info

  • NMW

  • Trade unions and collective bargaining

  • Labour immobility

  • Discrimination

  • Employment laws/regulations

Definitions:

Wage differential: The difference in wages between workers with different skills in the same industry or comparable skills in different industries or localities

Compensating wage differentials: Rewards for risk taking, working in poor conditions - usually a higher wage i.e. oil rig workers

Difference in productivity and revenue generation: Workers with high productivity who bring in a lot of revenue often have higher pay

Low skilled, elastic demand, elastic supply

Skilled workers, Inelastic demand, inelastic supply - they add value to the output of goods and services

Causes of pay gaps:

Gender pay gap : The difference between average hourly earnings of men and women as a proportion of average hourly earnings of mens earnings ( excluding over time )

Context - According to the Office for National Statistics (ONS), median hourly pay for full-time employees was 7.0% less for women than for men in April 2024

Discrimination: Due to race, age, sexual orientation, socioeconomic group

More causes:

  • Occupational segregation

  • Educational and occupational choices

  • Work experience and seniority

  • Negotiation and salary transparancy

  • Unconscious bias

  • Parental and care giving responsibilities

Wage setting in the public sector:

  • The govt. can impact the labour market

  • I.e. if wages are increased in the public sector this can increase pressure for private sector firms to increase their wage rates

  • Governments can also freeze public sector pay or increase it in line with inflation - or perhaps reduce it to put downwards pressure on inflation

  • Public sector workers who are unhappy with a real pay cut may take industrial action i.e. junior doctors in 2023/24 and bin men in Birmingham in 2025

Minimum and maximum wages:

Context:

  • U18’s minimum wage increased from £6.40 - £7.55

  • Living wage for over 25’s is £12.21 compared to £8.72 in 2020

  • This is where demand for labour is more inelastic

  • Therefore, there is less of a fall in employment

  • And those still in work will be acheieving a higher wage

  • However, when demand is more wage elastic

  • A minimum wage will have a larger impact on employment

  • I.e. low skilled, low pay jobs

However, if productivity improves as a result of an increase in minimum wage - employment may actually have a positive effect on employment at E3

Benefits of MW:

  • Fairer pay, less discrimination - so, less poverty, less worker exploitation

  • If higher pay improve productivity then this will have a positive effect on employment

  • May have a positive effect on the economy due to lower payed people having a higher MPC - in turn higher AD may result in high demand for labour

  • Help reduce inequality

  • Incentivises workers to actively look for work and get off of unemployment benefits and join the labour market which puts less pressure on the welfare state and reduces opportunity cost

Costs of MW:

  • Real wage unemployment

  • Only covers employees - self employed may be receiving less which doesn’t combat inequality - 3 million people in the UK

  • Increases costs to businesses - may result in technological unemployment because of AI

  • Could become inflationary if other workers try to maintain wage differentials with lower paid workers

  • Less international competitiveness due to higher LRAC - decrease in net exports - decrease in AD - reduced demand for labour

Trade Unions

  • Use collective bargaining over wages i.e. stronger together than apart

  • In 2023, UK trade union membership increased to 6.4 million, representing a 89,000 increase from the previous year,

  • Whereas In the 1970s, trade union membership in the UK was high, reaching a peak of around 13.5 million members in 1979, representing about 50% of the workforce.

Analysis:

  • Trade unions use collective bargaining to increase wages to WTU

  • This created the ‘trade unions’ supply at STU

  • At thus wage rate only QTU of labour is demanded, reduced from Q2

  • Therefore, causing unemployment

  • So, wages increase for workers until QTU but there is an excess supply of labour leading to unemployment increasing

  • Distorting efficient labour market efficiencies

  • Raising costs for a firm - may cause bankrupcy - long term wages may reduce further

Evaluation:

  • Trade unions may be beneficial in a monopsony as they have the power to set wages far below then market equilibrium - so by demanding higher wages here the TU may actually be benefitting more than harming workers and improving efficiency

  • Strength of TU power - depends on how powerful these trade unions actually are - if they’re illegal then they won’y have as much impact - the DENISTY - the greater the density, the greater bargaining power the TU has

  • Success determined by UNION MARK UP - this is the differences between workers in the same profession who are apart of a trade union and those who aren’t - the greater the union mark up then the greater success of the union

  • Real world evidence shows that the success of trade unions is limited - this is in part due to legislation - i.e. closed shop TU are no illegal, now harder to strike - 75% of union members have to agree, can only strike against your own employer - LIMITING strike action

Factors making it easier for trade unions to be effective ( pay increase with minimal job loss ):

  • Labour is a small % of total costs

  • Impossible to substitute labour with other factors of production

  • Demand for final product is inelastic - costs can be passed on to consumer

  • Trade unions control the supply of labour - closed shop

  • Firm is making SNP or substantial profits

  • Pay claim is accompanied by a productivity rise - therefore labour demand may also shift right

tradeunions

Monopsony power of labour

  • A sole employer of labour i.e. NHS

  • Wage maker

  • Will max revenue from workers by employing at MRP=MC

Analysis:

  • Monopsony will set wages at MC=MRP = QM = WM - much lower than their mrp

  • The lower the wages are than MRP the greater the monopsony power is - a measure of monopsony power

  • Compared to a competitive marker where wages would be at AC=MRP - wages and quantity are lower

  • Therefore, monopsonies cause lower wages and higher unemployment

Trade Unions effect on Monopsonies

  • We know that the monopsony wage and quantity level is at WM QM

  • Trade unions then - dependent on their union density - demand WTU

  • WTU then becomes the new AC and MC curve - as the monopsony becomes a wage taker - as all labour will now cost the same

  • But beyond that black dot, firms have to offer higher wages to attract new workers

  • And then the MC returns back to normal as all costs of labour equalise

Labour immobility and policies to prevent

Causes of occupational immobility

7.4% of worker shortages across all industries in 2022

52% skill shortage in construction - skills gap

Causes of occupational immobility

  • Work Visa’s can be used to reduce labour immobility

  • Another policy is increasing the size of the housing market

  • I.e. Labour aim to build 1.5 million homes in the next 5 years

Public Sector Wage Setting

As the government employ hundreds of thousands of people across the UK, pay legislation that they set such as the minimum wage can also have an effect on their expenditure in addition to that of private companies. For example, if the government employ a large amount of people on minimum wage, then an increase in minimum wage would see a large labour cost increase for them.

One of the main talking points at the moment is the wage increase public sector workers have received in comparison to inflation (as measured by CPI). Although, public sector workers have seen a wage rise, in real terms many of them are experiencing a decrease in their salary. As such, this has resulted in a squeeze on public sector workers as they see their disposable incomes decrease in real terms. However, due to the large number of employees that the government employ, increasing public sector wages by just 1% comes at a cost of around £2 billion. That being said, it can be argued that most of this money is earned back through increased income tax and the increase in consumer expenditure that a wage rise would result in, thus boosting the economic performance of the economy.