Transcript Lecture 5 Labor Market Equilibrium

Lecture 5
Labor Market Equilibrium
Workers prefer to work when the wage is high,
and firms prefer to hire when the wage is low.
Labor market equilibrium “balance out” the
conflicting desires of workers and firms and
determines the wage and employment observed
in the labor market.
1. Equilibrium in a Single Competitive Labor Market

The supply curve gives the
total number of employeehours that agents in the
economy allocate to the
market at any given wage
level; the demand curve
gives the total number of
employee-hours that firms
in the market demand at
that wage. Equilibrium
occurs when supply equals
demand, generating the
competitive wage w * and
employment E *.
Dollars
S
W*
D
E*
Employment
Equilibrium in a Competitive Labor Market
Note: There is no unemployment in a
competitive labor market. Persons
who are not working are also not
looking for work at the going wage.
2. Competitive Equilibrium Across Labor Markets
The economy typically consists of many labor markets, even for
workers who have similar skills. As long as either workers or firms
are free to enter and exit labor markets, a competitive economy will
be characterized by a single wage.
Dollars
SN
Dollars
S’S
S’N
SS
WN
W*
W*
WS
DN
Employment
DS
Employment
Competitive Equilibrium in Two Labor Markets Linked by Migration

Note: The “single wage” property of
competitive equilibrium has important
implications for economic performance. That
is, workers of given skills have the same value
of marginal product of labor in all markets.
The allocation of workers to firms which
equates the value of marginal product across
markets is also the allocation which maximizes
national income. This type of allocation is
called an efficient allocation.
3. Policy Application: Payroll Taxes

Payroll taxes on employers are heavily used in the
social insurance area. With our simple labor model,
we can show that the party making the social
insurance payment is not necessarily the one that
bears the burden of the tax.
Tax is a fixed dollar amount X.
D0→D1 with vertical distance of X.
pt. A: excess supply→ real wage↓
Employees bear part of the burden of the
payroll tax in the form of lower wage
rates and lower employment levels.
Tax
Real Wage
S0
W0+λ
W1+X
W0
W1
D0
D1
E2 E1 E0
Employment
Note: In general, the extent to which the
labor supply curve is sensitive to wages
determines the proportion of the employer
payroll tax that gets shifted to employee’s
wages.
4. The Cobweb Model

Our analysis of labor market equilibrium assumes that markets
adjust instantaneously to shifts in either supply or demand
curves, so that wages and employment change swiftly from the
old equilibrium levels to the new equilibrium level. Many
labor markets, however, do not adjust so quickly to shifts in
the underlying supply and demand curves.
 Example: the Engineering Market
Note: The adjustment of college enrollments to changes in the
returns to education is not always smooth or rapid, particularly
in fields that are highly technical.
→ The inability to respond immediately to changed market
conditions can cause boom-and-bust cycles in the market for
highly technical workers.
Wage
S
W1
W3
We
W2
D’
W0
D
N0 N2
N3 N1
Number of Engineers
Demand increase to D’; temporary supply is N0. → W increase to W1
→ W1 wage induce increase in supply to N1→ excess supply
→ W reduce to W2 → W2 wage reduce supply to N2
→ W increase to W3 → at W3 , supply increase to N3
→ excess supply → W reduces, etc.
Overtime the swings become smaller and eventually
equilibrium is reached. → cobweb model.
Note: There are two key assumptions in the cobweb model:
1.
2.
It takes time to produce new engineers, so that
the supply of engineers can be thought of as
being perfectly inelastic in the short run.
Students are very myopic when they are
considering whether to become engineers.
5. Policy Application: The Impact of Minimum Wages

The standard economic model of the impact of
minimum wages on employment is illustrated in the
following figure:
Dollars
S
W
W*
D
E
E*
ES Employment
The Impact of the Minimum Wage on Employment
Note: A minimum wage
creates unemployment
both because some
previously employed
workers lose their jobs,
and because some workers
who did not find it
worthwhile to work at the
competitive wage find it
worthwhile to work at the
higher minimum wage.
The Covered and Uncovered Sectors
Dollars
Dollars
S”U
SC
SU
W
S’U
W*
W*
DC
E
EC
(a) Covered Sector
Employment
DU
E”U EU E’U
Employment
(b) UNcovered Sector
The Impact of Minimum Wages on the Covered and Uncovered Sectors

Note: In the absence of a minimum wage, the
migration of workers across sectors equates the
wage in the two sectors. The migration of
workers when the wage in one of the markets
is set at the minimum wage equates the
expected wage across sectors. I.e., the free
migration of workers across sectors ensure that
the expected wage in the covered sector equals
the for-sure wage in the uncovered sector.
6. Noncompetitive Labor Markets
(1)
Monopsony
Because the firm is the only demander of labor in
this market, it can influence the wage rate.
Monopsnoists face an upward-sloping supply curve.
This is because the supply curve confronting them
is the market supply curve.
Note: To expand its work force, a monopsonist must
increase its wage rate, i.e., the marginal cost of
hiring labor excess the wage.
To maximize profits, we know that any firm should hire
labor until the points at which marginal revenue product
equals marginal cost.
MRP = MCL
MCL
W
S
Wages are below marginal
revenue product for a
monopsonist.
WC
Wm < WC and Em < EC
Wm
MRP
Em
Ec
L
(2) Monopoly
A monopoly trying to maximize profits and facing a
competitive labor market will hire workers until its
marginal revenue product equals the wage rate:
MRP = (MPL)(MR) = W
→ (MR/P)(MPL) = (W/P)
<1
The demand-for-labor curve for a firm that has
monopoly power in the output market will lie below
and to the left of the demand-for-labor curve for an
otherwise identical firm that takes product prices as
given.
Note: The wage rates that monopolies pay are not necessarily
different from competitive levels even though employment levels
are. An employer with a product market monopoly may still be a
very small part of the market for a particular kind of employee, and
thus be a price taker in the labor market even though a price maker
in the product market.
Dollars
A
W
VMPE
MRPE
Em
E*
Employment
The Labor Demand of a Monopolist