© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-1

Chapter Seven

Wages and Employment in a Single Labour

Market

Created by: Erica Morrill, M.Ed Fanshawe College

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-2

Chapter FocusEquilibrium in a single labour market Imperfect competitionPayroll taxesMonopsonyMinimum wage

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-3

Competitive Firm’s Demand

Assumptions : homogeneous type of labour price taker and wage taker

Supply is perfectly elastic (horizontal) at the wage rate

Firms can employ all the labour they need at the market wage rate

Market wage rate is set by the aggregate labour market

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-4

Figure 7.1 Competitive Product and Labour Markets

W

N

Wc

W

N

Wc

W

N

Wc

S

W0

W0

N01

N1 N02 N2 Ni

D=Di

S1S2

Firm 1 Firm 2 Aggregate Labour Market

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-5

Short-Run A firm may have to raise its wages to

attract additional workers dynamic monopsony

Short-run labour supply curve is upward sloping

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-6

Figure 7.2 The Labour Market in the Short Run and Long Run

Labour0

Wage

D

SS

S1

S’SSupply of workers increase depressing the high short run wage

D’

in demand leads to higher wages

WS

Wc

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-7

Short-run and Long-run Labour SupplyLong run

Temporary wage increases above norm are consistent with the firm being a competitive buyer of labour

Short-run wage increases can be a market signal ensures that market forces operate in the

longer run

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-8

Equilibrium in a Competitive MarketMarket-clearing model (neoclassical)

for markets with homogeneous workers and homogeneous jobs wages will be equalized across workers

absences of “involuntary unemployment” no queues for jobs or rationing of jobs

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-9

In Reality…. The market-clearing model is not entirely true

Wages do not adjust quickly to clear the market Involuntary unemployment is frequent Large wage differentials exist across

homogeneous workers and jobs.

However, it still serves as a useful approximation of market theory

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-10

Imperfect CompetitionMonopoly

is the industryEffects of hiring more labour

marginal physical product of labour falls marginal revenue falls Sells more output only by lowering the

product price

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-11

Figure 7.3 Monopolist Versus Competitive Demand for Labour

NNC*0

W*

NM*

DM = MPPN X MRQ= MRPN

DC = MPPN X PQ= VMPN

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-12

Product Market Structure and Departure from Market Wages

Monopolist earns higher profits and labour may be

able to appropriate some of these profits may be less cost conscious and may yield

to wage demands sensitive to public image pay higher wages

to buy good image large firms pay higher wages

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-13

Oligopoly in the Product Market Few firms Similar products Action of one firm affects the others May depart from Market wages because;

earn above normal profits which may be captured by workers

larger firms and may pay above-market wages for reasons related to size

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-14

Monopolistic Competition in the Product MarketMany small firms with differentiated

products giving the firm some discretion in price setting competitive in the labour market paying market wages no economic rents (high profits yielding

higher wages) no large size factors leading to higher

wages

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-15

Working with Supply and Demand

Simulating the effects of a policy change on equilibrium

Incidence of a unit payroll tax

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-16

Unit Payroll TaxTax levied on employersProportional to the firm’s payroll

CPP/QPP Workers’ compensation unemployment insurance health insurance

Often considered “job killers”

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-17

Figure 7.5 The Effect of a Payroll Tax on Employment and Wages

N0

W1

W0

A

T

NS

ND(W)

B

N1

ND(W+T)

C

D

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-18

Characteristics of a MonopsonyLarge relative to the size of the labour

market Influences wageRaises wages to attract labour Will not lose all of its work force if

decreases wagesUpward-sloping labour supply schedule

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-19

MonopsonyAverage cost is the wage rate Marginal cost is the new wage plus the

cost of paying the higher wage to existing workers

Marginal cost is higher than average cost

Profit Maximization when MC=VMP

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-20

Figure 7.6 Monopsony

Wage

0

VMPN=MPPnPQ

S=AC

MC

VM

NM

WMSM

WC

NC

S0

VMPM

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-21

Implications of a MonopsonyEmployment is lower than a competitive

situationRestricts employment because hiring

additional labour is costly Higher wages must be paid to

intramarginal workers

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-22

Characteristics of Monopsonists

Some inelasticity of supply of labour Most firms have an element of monopsony power in

short run Long run costly problems of recruitment, turnover

and morale issues Examples of monopsony in long run:

would be a one industry town in an isolated region if workers have specialized skills that are useful mainly in a

specific firm

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-23

Perfect Monopsonistic Wage Differentiation

Existing workers receive wages greater when a monopsony raises the wage rate seller’s surplus or economic rent

Monopsonist may try to retain some of this seller’s surplus by differentiating it’s work force

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-24

Perfect Monopsonistic Wage DifferentiationSupply schedule equal to the average

cost and marginal cost Does not have to pay existing workers

any more than their reservation wageMonopsonists may try to conceal higher

wages or use nonwage mechanisms to attract additional labour

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-25

Imperfect Monopsonistic Wage DifferentiationMonopsonists differentiate between

groups of workers different types of labour can be separated there are different supply elasticities

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-26

Minimum Wage Legislation: Impact on Competitive Labour Market

Adverse employment effect Firms employ less labour at a higher cost Higher wage encourages more people to

seek work Magnitude of adverse employment effect

depends on the elasticity of the demand for labour

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-27

Minimum Wage: Offsetting FactorsLabour could increase…

if there is exogenous increase in demand for output

if there is an increase in the demand for labour substitutes

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-28

Minimum Wage Legislation: Impact on Monopsony

minimum wage (or other form of price fixing) may increase employment

reduces monopsony profits depends on the extent to which

monopsony is associated with workers who are paid below minimum wage

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-29

Figure 7.9 Monopsony and Minimum Wage

MC

S=AC

VMP

N1N0

MC1

VMP0

W1

W0

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-30

Minimum Wage Reduces employment in competitive labour

markets Increases employment in monopsonistic

labour market Theory

Short-run effects are small Disemployment effects are higher in long-run

© 2002 McGraw-Hill Ryerson Ltd. Chapter 7-31

End of Chapter Seven