"Chemical Engineering Economics"

Assignment

Title: Wages and Employment in an Imperfectly

Competitive Labor Market

Submitted to: Engr. Zafar Shakoor

Submitted by: M. Furqan
Roll Number: 16103123-006
Submission Date: 14/07/2020
Department: BS Chemical Engineering
Imperfections in the Labour Market
In the real world, labour markets are rarely perfectly competitive. This is because workers or
firms usually have the power to set and influence wages and therefore wages may be set to levels
different than anticipated by Marginal Revenue Product (MRP) theory.
Imperfections in the labour market cause wages to differ from a competitive equilibrium.

Different Imperfections in the Labour Market

1. Monopsony
2. Trade unions
3. Discrimination
4. Difficult to measure productivity
5. Firms, not profit maximisers
6. Geographical immobiliities
7. Occupational immobilities
8. Poor information
1. Monopsony

Monopsony occurs when there is just one buyer of labour in a market. This gives the firm market
power in employing workers. The monopsony can set (lower) wages and limit the quantity of
workers.

 The marginal cost of employing one more worker will be higher than the average cost
because to employ one extra worker the firm has to increase the wages of all workers.
 To maximise the level of profit the firm employs Q2 of workers where MC = MRP
  Therefore the firm only has to pay a wage of W2. This is less than the competitive wage.
Even if there is more than one employer, firms may still have the ability to set wages and have a
degree of monopsony power. For workers, there are significant costs and difficulties in moving
between employers. This means that if wages are low, it is costly to give up the job and work for
a firm with slightly higher wages.

2. Trades Unions

Under certain conditions, Trades unions can bargain for wages above the competitive
equilibrium

This can be achieved by restricting the supply of labour (e.g. closed shops) or threatening to go
on strike.

Trades Unions can cause higher wages, however, in competitive markets, this can have the effect
of causing unemployment of Q1 – Q2

However, Trades Unions can be beneficial if:

 They operate in an industry with a Monopsonistic employer

 They help to increased productivity by bringing in new working practices
 Demand for labour is inelastic
 Efficiency wage theories – when higher wages lead to higher productivity.
3. Discrimination

Firms may not be rational but pay some workers different wages on the grounds of age, race, or
gender. See: discrimination in labour markets.

4. Difficult to measure productivity

The theory of MRP assumes firms can measure the MPP of a worker however in practice this is
difficult because in many jobs, especially in the service sector productivity cannot be measured
precisely
e.g. how do we measure the productivity of nurses and teachers?

Therefore wages may be set due to different reasons other than MRP

5. Firms may be non-profit maximisers

If demand for a product falls, MRP theory suggests wages are likely to fall. However, firms may
be reluctant to cut wages or make people redundant therefore they may keep paying high wages
despite this.

6. Wages will vary due to geographical differences

In the north (e.g. Sunderland), wages tend to be lower because there are less demand, higher
unemployment and more elastic supply curve of labour. In the South, wages tend to be higher for
the opposite reason – firms are more profitable and are willing to pay higher wages.

In theory, workers from the north could move to the south to take advantage of better
employment opportunities. However, there are likely to be geographical immobilities – e.g. it is
difficult for workers to move. Geographical immobilities can include

 Workers have attachments to their local communities – friends, children at local schools.
 Difficult to find housing in the south.
 Poor information about jobs elsewhere

7. Occupational immobilities

Even at periods of full employment (strong economic growth) workers can be unemployed due
to occupational immobilities. This involves having inadequate skills for the labour market. In a
fast-changing economy, some workers can be left behind when old industries close down and
their former skills are not transferable to new jobs. For example, manual workers from
manufacturing may struggle in a high tech service sector based economy. This can lead
to structural unemployment.

8. Poor information

Workers or firms may suffer from poor information. E.g. workers may be unaware of better-paid
jobs elsewhere. Poor information is one factor that enables firms to have monopsony power.

Conclusion

Should imperfectly competitive models be used whenever researchers are modelling the labour
market? Some people would argue only in cases when the 21 predictions and comparative statics
of the imperfectly competitive model differ from those of the competitive model. Of course, to
know this, one needs to know precisely what the predictions and comparative statics of the
respective models are. However, there is now a growing – and some would suggest, lamentable -
trend for labour economists not to use any analytical framework. The syllabuses of some labour
economics courses

I have seen include little about imperfectly competitive models. Moreover,

atheoreticrandomised experiments are increasingly being used in labour economics and represent
an alternative methodology that can reveal the effect of an intervention without the need for any
analytical framework. Nonetheless, for policymakers to be able to determine if an intervention is
required in the first place, there does need to be some analytical framework to act as a guide. In
the perfectly competitive model of the labour markets, for example, typically no intervention or
regulation would be justified. However, labour economics has moved far beyond this position,
with new ideas being incorporated into modeling wage determination in imperfectly competitive
labour markets and with the availability of better datasets