Chapter 5

Labor Market Equilibrium

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Labor Market Equilibrium

Competitive Markets (firms and workers can freely enter and exit ) Equilibrium outcome will be efficient

Monopsonies E*↓, w*↓ relative to competitive markets

Monopolies:Applications: Taxes Subsidies Immigration

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Equilibrium in a Single Competitive Labor Market

Equilibrium:

Each firm hires up to the point whereNo 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

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Competitive Equilibrium Across Labor Markets

Labor markets may be differentiated by: Region (north, south, etc) Industry (2 different production industries)

Assume: Markets in two regions (north, south) Workers in the two regions have similar

skills and can substitute for one another Initially, ws < wn

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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,

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Competitive Equilibrium Across Labor Markets Efficiency

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 maximized

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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 30-year 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

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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

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Policy Application: Payroll Tax

Payroll tax Employers pay a tax on total

wage bill

Employers who first paid w1 will now be willing to pay only _____ to E1 workers _____ward shift of labor

demand curve New wage paid to workers: Firms pay _____, because they pay tax t to the government ______ workers hired (E2 _ E1) Tax burden Firms: Employees:

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Policy Application: Employee Tax

Tax on workers E1 workers first earned w1,

Workers now demand ______ ______ward shift of labor supply

curve

New wage is ____Workers earn _____, because they pay tax t to government _____ workers hired (E2 _ E1)

Tax burden Firms: Employees:

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Tax policy application: Summary

Note that the outcome is the same regardless of who is taxed 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)

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Tax with no burden on the firm

Assume firm is taxed Assume perfectly inelastic supply 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

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Empirical Example

Note: Evidence suggests firms pass approximately 90% of tax burden onto employeesSuppose 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 annually Average worker only receives $7,200

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Policy Application: Government subsidy paid to employers

Subsidy lowers the cost of hiring workersFirms 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 Firm: Worker:

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Empirical Example

Assume: 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

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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

Monopsony:

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

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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*

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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

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Non-discriminating Monopsonist, cont.

Firms hire up to the point where ___ = ____ (EM,wM)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

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Monopsony and Minimum Wage

Set wmin > wM, and firm can hire E* employees MC = wmin up to E* employees, then returns to MC curve above supply curve Firm wants to hire where ______ = _____, which is E* employees (point A) at min wage, wmin Outcome: wmin _ wM and E* _ EM- no 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

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Competitive firms facing upward-sloping 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

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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,

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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

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Noncompetitive Labor Markets: Monopoly

Monopoly:

Recall: Monopsonist did not control p, but could choose w

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Monopoly, cont.

When output increases, monopolist must ______ price on that unit and all previous units 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

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Monopoly, cont.

Since P≠MR, revenue generated by last worker hired is not equal to MPE·P = VMPE

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

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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