Transcript Chapter5

Labor Market Equilibrium
Chapter 5
Labor Market Equilibrium
Competitive Markets (firms and workers can freely
enter and exit )
Equilibrium outcome will be efficient 
E*↓, w*↓ relative to competitive markets
Equilibrium in a Single
Competitive Labor Market
Each firm hires up to the point
No unemployment
Anyone who wants to work at w* can
Individuals not working are looking
for w_w*
Firms not finding employees are
offering w_w*
Realistically, equilibrium will not
last because of shocks in modern
industrialized nations
Competitive Equilibrium
Across Labor Markets
Labor markets may be differentiated by:
Region (north, south, etc)
 Industry (2 different production industries)
Markets in two regions (north, south)
 Workers in the two regions have similar skills and
can substitute for one another
 Initially, ws < wn
Competitive Equilibrium
Across Labor Markets, cont.
If workers have full mobility, southern workers will ___________
____________ where they can earn a higher wage
If firms have full mobility, northern firms will _______________
where they can pay a lower wage (not shown)
In the end,
Competitive Equilibrium Across
Labor Markets  Efficiency
Also maximizes national income
 If ws < wn, VMPs _ VMPn since profit-maximizing
firms hire up to the point where
 As workers migrate north, MPn_ and MPs_ until the
two are equated, and
 In the end, ___________________, and profits are
Empirical Evidence
Do wages equate over time?
In the US, there is a strong ____________ correlation between
wages and annual growth of wages
Roughly 30% of the wage gap between states disappeared over a 30year period (states with lowest wages had highest growth rate)
Similar evidence in Japan, a less mobile country
Across countries: “Conditional convergence”
Does not apply to the wage gap between the rich and poor
countries because countries with lower human capital levels
do not grow as rapidly
NAFTA: Mexico and the US
Mobility of firms should:
__crease demand for Mexican workers
 __crease demand for US workers with similar skills
 Eventually _______ wages across the two countries
Some workers will clearly benefit and some will
be harmed, but the total income of the two
countries should increase as North America
moves to a more __________ outcome
Policy Application: Payroll Tax
Payroll tax
Employers pay a tax on total wage
Employers who first paid w1 will
now be willing to pay only _____
to E1 workers
_____ward shift of labor demand
New wage paid to workers:
Firms pay _____, because they
pay tax t to the government
______ workers hired (E2 _ E1)
Tax burden
Policy Application: Employee Tax
Tax on workers
E1 workers first earned w1,
Workers now demand ______
______ward shift of labor supply
New wage is ____
Workers earn _____, because
they pay tax t to government
_____ workers hired (E2 _ E1)
Tax burden
Tax policy application: Summary
Note that the outcome is the same regardless of who is
Employee Tax:
w_, so ______ bears the cost by having to ________________
Full amount of tax not recovered for ________ (tax is greater
than the wage increase)
Payroll Tax:
w_, so _______bear the cost by ____________
Full amount of tax is not covered for ___________ by the
wage decrease (tax is greater than the wage decrease)
Tax with no burden on the firm
Assume firm is taxed
Assume perfectly inelastic
With tax, firm is only willing
to pay ______
Number of workers
________ _____________
Firm passes entire incidence of
the tax onto workers
Therefore, a more ________
supply curve passes more tax
burden onto employees
Recall that labor supply curve
for men is inelastic
Empirical Example
Note: Evidence suggests firms pass approximately 90%
of tax burden onto employees
Suppose annual income = $30,000
Employee tax = 7.65%  $2295 annually
Employer tax = 7.65%  $2295 annually
90% of tax shifted to worker: .9·2295 = $2066
Total employee tax = $2295 + 2066 = $4361 annually
If $4361 were invested annually at 3%, worker would
accumulate $263,675 by age 65
If worker lives to age 80, would need SS benefits of $21,000
Average worker only receives $7,200
Policy Application: Government
subsidy paid to employers
Subsidy lowers the cost of hiring
Firms are willing to pay ______
(s recouped in the form of the
subsidy, so in essence, the firm is
only paying original wage, w1)
New wage paid to worker: __
Cost of employment for the firm:
Benefits of subsidy
Empirical Example
Elasticity of demand = -0.5
Elasticity of supply = 0.3
A 10% subsidy (reduction in hiring costs) would:
Increase wage by 4%
Increase employment by 2%
Gains of a government subsidy may be limited
Firms may be unaware of programs
Firms may place a stigma on hiring targeted workers and do not
hire them even to benefit from employer subsidy programs
Noncompetitive Labor
Markets: Monopsony
So far, competitive firms took p and w as given regardless of E*
Recall that perfectly competitive firms face a horizontal demand
curve given by the market price
Analogously, an individual firm faces a horizontal labor supply
curve, given w
It can hire as many workers as it long as it pays wage = w
Must pay higher wages to attract more workers (p taken as given)
Note that all markets have upward-sloping supply curves, but
monopsonies are firms that face upward-sloping supply curves
Ex: one-company town
Perfectly discriminating monopsonist
Monopsonist can hire different workers
at different wages
w15 for worker 15,
w20 for worker 20, etc.
Supply curve = ____
Wage paid for each worker is his ______
Demand curve = ______
Price is taken as given
Firm hires up to the point where _____
____ (E*,w*), or where _____ = ______
Same __ as a competitive market, but __
is the wage for the last worker, and all
others were paid w _ w*
Non-discriminating Monopsonist
Monopsonist pays all workers the same wage,
regardless of their reservation wages
Supply ≠ MC, but MC __creases as E increases
S _ MC
If the 9th worker costs $7, total labor bill = $63
If 10th worker demands $7.50, total labor bill = $75
MC of the 10th worker is $12, but wage was $7.50
Analogous to D > MR for a monopolist
Non-discriminating Monopsonist, cont.
Firms hire up to the point
where ___ = ____
Monopsonist determines
wage from _______
curve, not MCE curve
Similar to how
monopolists choose P
from the demand curve,
not MR
EM _ EC and wM _ wC
Monopsony and Minimum Wage
Set wmin > wM, and firm can hire E*
MC = wmin up to E* employees, then
returns to MC curve above supply
Firm wants to hire where ______ =
_____, which is E* employees (point
A) at min wage, wmin
Outcome: wmin _ wM and E* _ EMno unemployment
Better outcome: set wmin = __ so E
= __ and w = __
Minimum wage law outcomes may
be explained by fast food restaurants
acting as monopolists to teenagers
Competitive firms facing upwardsloping supply curves
Even if employees are mobile, the costs
associated with moving to take advantage of a
new higher paying job can be huge
Competitive firms must offer large wages to attract
someone to move
As the number of employees increases,
monitoring workers to discourage shirking
becomes expensive
Employers may want to pay higher wages to make
the cost to an employee of shirking more expensive
Professional Athletes
Free agency
If a player can go where he wants, he will present his current
team with an outside offer
Current team evaluates VMP, and if VMP exceeds offer,
If not,
No free agency
New team can offer current team a trade – pay salary +
bonus to total their value for the player
Current team evaluates VMP and agrees to trade if
If VMP exceeds offer,
Professional Athletes, cont.
Allocation of resources (players)
Player may not be paid according to worth, but he ends
up with the team that values him the most (VMP) in
either case
Different income distribution
__________ benefits from no free agency, but ________
benefits as a free agent
Empirical evidence: supports migration and income
distribution predictions
Noncompetitive Labor
Markets: Monopoly
Recall: Monopsonist did not control
p, but could choose w
Monopoly, cont.
When output increases,
monopolist must ______ price
on that unit and all previous
MR _ P, where P is represented
by ______ since the firm chooses
P* from demand curve after Q*
is chosen (MR=MC)
Competitive outcome: ______
PC _ PM and QC _ QM
Monopoly, cont.
Since P≠MR, revenue generated
by last worker hired is not equal
Instead, marginal revenue
product = MRPE =
MPRE _ VMPE because MR < P
π-max: w = ___, not w = VMP
EM _ EC, where EC is found be
equating wage to value of
marginal product
Empirical Evidence
Monopolists and oligopolists (few firms
produce all of the output for an entire
market) pay higher wages than competitive
firms (approximately 10% more)
Monopolists can pass high production costs
onto consumers, so with little incentive to
keep costs down, monopolists must pay high
wages for the most desirable workers