gsb728 lecture note topic 3b

Economics for Management

GSB728

Topic 6:

Economics of Employment

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Note: This lecture note was prepared based on the teaching material provided

by the publisher of the textbook Principles of Economics.

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Learning Objectives1. Labour market trends – How has the pattern of work

changed in recent years?

2. Wage determination in a perfect market – Why are some people paid higher wage rates than others?

3. Wage determination in imperfect markets? – How are wage rates affected by big business and by unions?

4. Causes of inequality – Why are some people rich and others poor?

5. The redistribution of income – How can income be redistributed from rich to poor? What will be the effects of doing so? 3

Labour Market Trends

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• Change in pattern of employment:

– Sectoral shift from agricultural and manufacturing to service-sector employment.

• Rise in part-time employment.

• Fall in full-time employment.

• Rise in casual employment.

• Increase in female participation.

• Firm downsizing.

Labour Market Trends (contd.)

Employment by Industry in Australia: 1980 vs. 2008

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Source: Sloman et al. (2014).

Wage Determination in Perfect Market

• Perfect labour markets:

• Everyone is a wage taker.

• Freedom of entry.

• Perfect knowledge.

• Homogeneous labour.

• Equilibrium.

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S all workers in the market

D all firms in the market

0Labour hours

Hourly wage

Wm

Perfectly Competitive Labour Market

QlhSource: Sloman et al. (2014).7

• The supply of labour:• Upward-sloping curve.• The position of the supply curve depends on:

– The number of qualified people.– Non-wage benefits or cost of the job.– Desirability of alternative jobs.

• The elasticity of supply of labour:• How responsive will the supply of labour be to a

change in the wage rate?• Difficulties and costs of changing jobs (mobility

of labour).• Time period.

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Wage Determination in Perfect Market (contd.)

• The demand for labour: Marginal productivity theory.

– Profit-maximising approach:• MC of labour = MR of labour

– Measuring the marginal cost and revenue of labour:

• Marginal cost of labour (MCL) = Wage rate (W).

• The marginal revenue product of labour (MRPL): Extra revenue a firm earns from employing one more unit of labour: MRPL = MPPL x MR

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0Q L

Output

MPPL

Marginal Physical Product of Labour

Q of labour

Diminishing returnssets in here

10Source: Sloman et al. (2014).

• Profit-maximising level of employment for a firm.

• Derivation of the firm’s demand curve for labour.

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0

$

Wm MCL= Wm

Qe Q of labour

MRPL = MPPL × Pgood

The Profit-Maximising Level of Employment

Source: Sloman et al. (2014).12

0Q of labour

$

MRPL= MPPL x Pgood

W1 MCL1

Q1

MCL2W2

MCL3W3

Q2 Q3

a

b

c

Deriving the Firm’s Demand Curve for Labour

Profit maximised whereMRPL= MCL


0Q of labour

$

D = MRPL

W1MCL1

Q1

MCL2

W2

MCL3W3

Q2 Q3

a

b

c

The MRPL curve definesthe demand for labour


Deriving the Firm’s Demand Curve for Labour (contd.)

• Determinants of demand for labour:

– Wage rate (MCL).

– Productivity of labour (MPPL).

– Demand for the good (demand for labour is derived demand from the demand for the good).

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– Market demand and elasticity:• Market demand curve downward sloping as

the firm’s demand for labour is downward sloping.

• Determinants of elasticity of market demand:– The price elasticity of the good or service.– The ease of substitution between labour and

other factors.– Wage cost as a proportion of total cost.– The time period.

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So, how are the wages and profits under perfect competition?

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• The wage rate is determined by the interaction of demand and supply in the labour market.

• Profits to the individual firm will be as presented in the next slide.

0

MCL = W

Surplus for firm

Wages

W

Qe Q of labour

$

MRPL

Wages and a Firm’s Surplus Over Wages


• Effect of big business and unions on wages (power in labour markets):

• Firms with monopsony power.

• Monoposonists are wage setters.

– MCL > W.

– Effects on wages and employment.

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Wage Determination in Imperfect Markets

0Q of labour

$

MRPL

Q1

MCL

W1

Q2

W2

ACL = W

(supply curve)

Monopsony


• The role of trade unions:

– Unions and market power.

– Unions facing competitive employers.

– Effects of wage increases on employment.

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Wage Determination in Imperfect Markets (contd.)

0Q of labourQ1

S

D

$

W1

Unemployment

Q3Q2

W2

Monopoly Union Facing Producers Under Conditions of Perfect Competition


• Bilateral monopoly:

• No unique equilibrium.

• Relative bargaining strengths determine equilibrium.

• Unions may be stronger when facing stronger employer.

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• The efficiency wage hypothesis:– Higher wage rates may lead to higher

productivity:• Less ‘shirking’ or careless behaviour at work. • Reduced labour turnover.• Morale (create the feeling that the firm is a “good”

employer that cares about its employees).

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• Inequality in Australia:

– Distribution of income (in the society).

– Distribution of wages and salaries by occupation.

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Causes of Inequality

Bottom20%

Next 20%

Middle20%

Next 20%

Top20%

17.9%

23.4%

37.4% 13.2%

8.2%

Distribution (%) of Australian Household Income by Quintile Group, 2003-04


• Causes of inequality/differences in earnings:

• Differences in ability.

• Differences in attitude.

• Differences in qualifications.

• Differences in hours worked.

• Differences in pleasantness of job.

• Differences in power.

• Differences in the demand for goods.

• Discrimination.27

Causes of Inequality (contd.)

Income Redistribution

• Taxation:

• Direct taxes (paid directly by the taxpayer to the taxation office, e.g.: income).

• Indirect taxes (paid through a middle person, e.g.: alcohol tax)

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– Redistribution of income and tax: ‘progressiveness’

• Progressive tax (the percentage of income paid increases as people income rises).

• Regressive tax (the percentage of income paid decreases as people income rises).

• Proportional tax (the percentage of income paid remains constant as people income rises).

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Income Redistribution (contd.)

– Taxation and incentives.

– Effect of raising income taxes:

• Income effects:

– Reduces disposable income: People work more to maintain their consumption level.

• Substitution effects:

– Reduces opportunity cost of leisure: People work less, because people ask: What is the point of doing overtime if I have to pay so much in taxes?

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• Benefits:

– Cash benefits:

• Means-tested benefits (available only to those whose income or assets fall below a certain level).

• Universal benefits (paid to everyone in a certain category irrespective of their income or assets, e.g.: Child Disability Allowance).

– Benefits in kind (goods or services that the state provides directly to the recipient at no charge or at subsidised price. The state also may subsidise the private sector to provide these goods and services). 31


– The tax/benefit system and the problem of disincentives:

• When means-tested benefits are combined with a progressive income tax system, there can be disincentives to work.

• What is the point of getting a job or trying to earn more money if you end up earning little more or actually losing money?

• The ‘poverty trap’ (poor people are discouraged from working or getting a better job as they will end up in a worst income scenario).

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References

Morales, L. E., Simons, P. and Valle de Souza, S. (2014). GSB728: Economics for Management [Topic Notes]. Armidale, Australia: University of New England, Graduate School of Business.

Sloman, J., Norris, K and Garratt, D. (2014). Principles of Economics (4th ed.). French Forest, Australia: Pearson.

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gsb728 lecture note topic 3b

Economy & Finance