Wages and Employment in A Single Labour Market

10/27/2008
Chapter Seven
Competitive Firms Demand
Wages and Employment in a Single Labour

Market
Perfect competition in both the

product and the labour markets
Assumptions:
homogeneous type of labour
price taker and wage taker
Supply of labour 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
Prepared by Dr. A. Noordeh

York University
Assisted by I. Bershad
Chapter 7
2007 McGraw-Hill Ryerson Ltd.
Chapter 7
Equilibrium in a Single Competitive Labour

Market
Imperfect Competition
Payroll
P
ll T
Taxes
Monopsony
Minimum Wage
W
W0
Wc
S2
Wc
Wc
D=Di
Firm 1
2
W0
S1
N 01 N 1
Competitive Product and Labour Markets
Learning Objectives
Chapter 7
Chapter 7
N 02
N2
Firm 2
Ni
Aggregate Labour Market

4
10/27/2008
Equilibrium in a Competitive Market
Short Run vs. Long Run
Characteristics of the long run equilibrium

and the market-clearing model (neoclassical)
for markets with homogeneous workers and
homogeneous
g
jjobs, wages
g will be equalized
q
across workers
absences of involuntary unemployment
no queues for jobs or rationing of jobs
In the short run a firm (firms) may raise its

(their) demand for additional workers as
demand for its (their) product increases.
Given the upward sloping labour supply
curve, the
th wage rate
t as wellll as employment
l
t
will increase in short run.
Short-run wage increases can be a market
signal, resulting in increase in the labour
force in long run (labour supply curve shifts to
the right).
Chapter 7
Chapter 7
The Labour Market in the Short Run and

Long Run
Wage
In Reality
The market-clearing model is not entirely true
SS
Wages do not adjust quickly to clear the market

Involuntary unemployment is frequent
Large wage differentials exist across
homogeneous workers and jobs.
SS
W1
Wc
S1
However, the neoclassical model still serves as

a useful approximation of the market theory
D1
D
0
Chapter 7
Labour
Chapter 7
10/27/2008
Product Market Structure and Departure

from Market Wages
Imperfect Competition
Monopoly
Effects of hiring more labour
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 and may pay higher
wages to buy good image
large firms do tend to pay higher wages
marginal physical product of labour falls

marginal
i l revenue ffalls
ll
sells more output only by lowering the product
price
Chapter 7
Chapter 7
Monopolist Versus Competitive Demand for

Labour
DC = MPPN X PQ= VMPN

DM = MPPN X MRQ= MRPN
0
Chapter 7
NM*
NC*
11
Oligopoly in the Product Market
W*
W
Few firms
Similar products
Action of one firm affects the others
May depart from market wages because:
Firms earn above normal profits, some of which
may be captured by workers since larger firms
may pay above-market wages
N
10
Chapter 7
12
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Monopolistic Competition in the

Product Market
Unit Payroll Tax
Many small firms with differentiated products

giving the firm some discretion in price setting
Short-Run
Tax levied on employers

Proportional to the firms payroll
CPP/QPP
Workers
W k compensation
ti
Unemployment insurance
Health insurance
Earn Economic Profit

Able to pay higher than the market wage
Long-Run
No Economic Profit
Has to pay the market wage
Chapter 7
Often considered job killers

13
Chapter 7
15
The Effect of a Payroll Tax on Employment and

Wages
Working with Supply and Demand

Simulating the effects of a policy
change on equilibrium
Incidence of a unit payroll tax
NS
D
W0
W1
ND(W)
ND(W + T)
N1
Chapter 7
14
Chapter 7
N0
16
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Monopsony
Monopsony
A monopsony is a large firm relative to the

size of the labour market
It influences the wage rate
It mustt raise
i wages tto attract
tt t labour
l b
( i
(since
S curve not perfectly elastic)
Will not lose all of its work force if wages
are decreased
Upward-sloping labour supply schedule
Chapter 7
17
Wage
VMPM
WC
WM
VM
SM
0
Chapter 7
VMPN = MPPNXPQ
Nm
Nc
Labour (N)
19
Implications of a Monopsony
Average 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
S=AC
S0
Monopsony
Chapter 7
MC
Employment is lower than a competitive

situation
Restricts employment because hiring
additional labour is costly
Higher wages must be paid to intramarginal workers (i.e., those hired first)
18
Chapter 7
20
10/27/2008
Perfect Monopsonistic Wage

Differentiation
Characteristics of Monopsonistic Market

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 off monopsony in long run:
Supply schedule equals to the average

cost and marginal cost
Does not have to pay existing workers any
more than their reservation wage
Monopsonists may try to conceal higher
wages or use nonwage mechanisms to
attract additional labour
would be a one industry town in an isolated

region
if workers have specialized skills that are useful
mainly in a specific firm (lesson here is avoid
firm-specific human capital)
Chapter 7
21
Perfect Monopsonistic Wage

Differentiation
sellers surplus or economic rent
Monopsonist may try to retain some of this

sellers surplus by differentiating its work
force
23
Minimum Wage Legislation: Impact on

Competitive Labour Market
Existing workers receive higher wages

when a monopsony raises the wage rate
Chapter 7
Chapter 7
22
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 as well as the elasticity of supply
Chapter 7
24
10/27/2008
Minimum Wage: Offsetting Factors

Labour could increase
if there is an exogenous increase in demand
for output
if there is an increase in the demand for
labour substitutes (and hence the labour that
produce these)
Chapter 7
End of Chapter Seven
25
Chapter 7
27
Summary
The determinants of employment and wage rate
in a single market under perfect competition
The impact of imperfectly competitive product
market on the labour market
The impact and the incidence of payroll taxes on
the labour market
Monopsonistic labour market
Minimum wage
Chapter 7
26

Wages and Employment in A Single Labour Market

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10/27/2008

Competitive Firms Demand

Wages and Employment in a Single Labour

Perfect competition in both the

Supply of labour is perfectly elastic

Prepared by Dr. A. Noordeh

2007 McGraw-Hill Ryerson Ltd.

Equilibrium in a Single Competitive Labour

2007 McGraw-Hill Ryerson Ltd.

Competitive Product and Labour Markets

2007 McGraw-Hill Ryerson Ltd.

Aggregate Labour Market

Equilibrium in a Competitive Market

Short Run vs. Long Run

Characteristics of the long run equilibrium

In the short run a firm (firms) may raise its

2007 McGraw-Hill Ryerson Ltd.

The Labour Market in the Short Run and

Wages do not adjust quickly to clear the market

2007 McGraw-Hill Ryerson Ltd.

However, the neoclassical model still serves as

2007 McGraw-Hill Ryerson Ltd.

Product Market Structure and Departure

marginal physical product of labour falls

2007 McGraw-Hill Ryerson Ltd.

Monopolist Versus Competitive Demand for

DC = MPPN X PQ= VMPN

Oligopoly in the Product Market

2007 McGraw-Hill Ryerson Ltd.

2007 McGraw-Hill Ryerson Ltd.

Monopolistic Competition in the

Unit Payroll Tax

Many small firms with differentiated products

Tax levied on employers

Earn Economic Profit

2007 McGraw-Hill Ryerson Ltd.

Often considered job killers

2007 McGraw-Hill Ryerson Ltd.

The Effect of a Payroll Tax on Employment and

Working with Supply and Demand

2007 McGraw-Hill Ryerson Ltd.

A monopsony is a large firm relative to the

2007 McGraw-Hill Ryerson Ltd.

2007 McGraw-Hill Ryerson Ltd.

Average cost is the wage rate

2007 McGraw-Hill Ryerson Ltd.

Employment is lower than a competitive

2007 McGraw-Hill Ryerson Ltd.

Perfect Monopsonistic Wage

Characteristics of Monopsonistic Market

Supply schedule equals to the average

would be a one industry town in an isolated

2007 McGraw-Hill Ryerson Ltd.

Perfect Monopsonistic Wage

sellers surplus or economic rent

Monopsonist may try to retain some of this

2007 McGraw-Hill Ryerson Ltd.

2007 McGraw-Hill Ryerson Ltd.

Minimum Wage Legislation: Impact on

Existing workers receive higher wages

Adverse employment effect

2007 McGraw-Hill Ryerson Ltd.

Minimum Wage: Offsetting Factors