Wage Determination - Chapter 17 Notes

Wage Determination

Labor, Wages, and Earnings

  • Wages: The price paid for labor, including direct pay and fringe benefits.
  • Wage rate: The price of labor per unit of time (e.g., hourly, daily).
  • Nominal wage: The amount of money received per unit of time.
  • Real wage: The purchasing power of nominal wages; adjusted for inflation.
  • General level of wages

Role of Productivity

  • Labor demand is closely tied to productivity.
  • The high productivity of U.S. labor is attributed to:
    • Plentiful capital resources.
    • Access to abundant natural resources.
    • Advanced technology.
    • High labor quality.
    • Other contributing factors.

Competitive Labor Market

  • Purely competitive labor market: A market where numerous firms compete to hire a specific type of labor, and no single firm or worker can influence the market wage rate.
  • Market demand for labor: The sum of individual firm demands for labor.
    • Example: carpenters
  • Market supply for labor: Typically upward sloping, indicating that more workers are willing to work at higher wage rates.
  • Competition among industries
  • Labor market equilibrium: The point where the market demand for labor equals the market supply of labor.
    • MRP = MRC rule: Firms will hire workers up to the point where the marginal revenue product (MRP) of labor equals the marginal resource cost (MRC) of labor.

Supply of Labor: Pure Competition

  • In a purely competitive labor market, the supply of labor is perfectly elastic at the market wage rate.

Monopsony Model

  • Monopsony: A market situation in which there is only one buyer of labor.
  • Characteristics:
    • Single buyer of labor.
    • Labor is relatively immobile or lacks alternative skills.
    • The firm is a "wage maker," meaning it has the power to influence wage rates.
    • The labor supply curve is upward sloping to the firm.
    • Marginal resource cost (MRC) is higher than the wage rate.

Wage Rate and Employment in Monopsonistic Labor Market

  • A monopsonist maximizes profit by hiring fewer workers and paying a lower wage rate compared to a competitive market.

Supply of Labor: Monopsony

  • Under monopsony, the marginal resource (labor) cost increases at an increasing rate.

Monopsony Power

  • Firms with monopsony power maximize profit by hiring a smaller number of workers.
  • Examples of monopsony power:
    • Nurses in some geographic locations.
    • Professional athletes (before free agency).
    • Teachers in districts with little competition.

Unions and Demand Enhancement

  • Unions may try to increase the demand for labor to increase wages and employment.

Exclusive or Craft Union Model

  • These unions aim to raise wages by restricting the supply of labor.
  • Methods to reduce labor supply:
    • Restricting immigration.
    • Reducing child labor.
    • Encouraging compulsory retirement.
    • Enforcing a shorter workweek.
    • Exclusive unionism.
    • Occupational licensing.

Exclusive or Craft Unionism

  • By decreasing the supply of labor, exclusive unions can achieve higher wages for their members.

Inclusive or Industrial Unionism

  • Inclusive unionism (e.g., auto and steel workers) seeks to organize all workers in an industry to increase their bargaining power.

Wage Increases and Job Loss

  • Unions can be successful in raising wages (on average, 15% higher).
  • Consequences:
    • Higher unemployment rates in unionized industries.
    • Restricted ability to demand ever-increasing wages.

Bilateral Monopoly Model

  • Bilateral monopoly: A market structure with a monopsony (single buyer) and an inclusive union (single seller) of labor.
  • Not uncommon in certain industries.
  • The outcome is indeterminate and depends on bargaining power and negotiation skills.

Bilateral Monopoly in the Labor Market

  • The wage and employment levels are determined through bargaining between the monopsonist employer and the union.

Minimum-Wage Controversy

  • Arguments against minimum wage:
    • Reduced employment.
    • Inefficient labor allocation
  • Arguments for minimum wage:
    • Poverty reduction.
  • State and locally set rates
  • Evidence and conclusions

Wage Differentials

  • Wage differences exist across occupations due to several factors:
    • Marginal revenue productivity differences.
    • Noncompeting groups (varying skills and qualifications).
    • Ability.
    • Education and training levels.
    • Human capital investments.
    • Compensating differences (premium for undesirable jobs).

Other Reasons for Wage Differentials

  • Workers may be prevented from moving to higher-paying jobs due to:
    • Lack of job information.
    • Geographic immobility.
    • Union and government restraints.
    • Discrimination.

Pay for Performance

  • The principal-agent problem: Occurs when the interests of the employer (principal) and employee (agent) are not perfectly aligned.
  • Incentive pay plans:
    • Piece rates (payment per unit produced).
    • Commissions or royalties (percentage of sales).
    • Bonuses, stock options, and profit sharing.
    • Efficiency wages (above-market wages to increase productivity).
  • Negative side-effects

Occupational Licensing

  • Occupational licensing is common for professions like doctors and EMTs.
  • However, nearly 1 in 3 jobs today require a license, which can restrict competition and increase prices.
  • This creates a burden on consumers and workers.
  • Low-wage jobs like cosmetology, childcare, floristry, massage therapy, and travel agency often require licenses.