Chapter 14

Labor
Markets

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 In this chapter you will learn to

1. Explain why wage differentials exist in both competitive

and noncompetitive labor markets.
2. Describe the effects of legislated minimum wages.

3. Explain why unions face a tradeoff between wages and

employment.
4. Describe facts and to recognize government policies related
to gender and race issues in the labor market.
5. Explain why the trend away from manufacturing jobs and
toward service jobs is not necessarily a problem for the
economy as a whole.
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Wage Differentials

Wage Differentials in Competitive Markets

In competitive labour markets, supply and demand set the

equilibrium wage and level of employment.

But wages will still differ across workers if there are

compensating differentials.

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Wage Differentials

Even if all jobs are the same (no compensating differentials),

there may still be some equilibrium wage differentials:

- different working conditions

- inherited skills are different across workers and can

be important

- investment in human capital is costly, and the return

is usually in terms of higher future wages

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Figure 14.1 Education and Earned
Income in the United States, 2005

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Wage Differentials and Human Capital

Changes in the pattern of human-capital acquisition lead to

changes in the supply of high-skilled versus low-skilled
labour.
These changes erode the wage differentials.
But as long as human capital is costly to acquire, some
wage differentials will persist in equilibrium.

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 Wage Differentials in Noncompetitive
Markets

A Union in a Competitive Labor Market

A labor union has monopoly power:

- it can change the supply of labor
 driving up the wage

Firms are generally able to choose the level of employment,

once the wage is determined in negotiations.

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Figure 14.2 A Union in a
Competitive Labor Market

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Figure 14.3 Monopsony in a
Labor Market

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Figure 14.4 Bilateral
Monopoly in a Labor Market

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Bilateral Monopoly: Monopsony
with a Labor Union

MC The union can raise

wages and
Wage

S = AC
Rate

employment above
• the monopsony levels.
w0 • E0
E1 If the union pushes
w1 • wages up only to the
competitive level,
MRP employment would also
L1 L0 rise to the competitive
Quantity of Labor level.

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Bilateral Monopoly: Monopsony
with a Labor Union

MC But if the union pushes

the wage up to w2,
Wage

S = AC
Rate

employment will fall

E2 x
w2 • • below the competitive
w0 • E0 level…
E1
w1 •

MRP
…and some
unemployment occur.
L1 L2 L0 L3
Quantity of Labor

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 Legislated Minimum Wages

Government policy can affect labor markets by legislating

minimum wages.

In a competitive market, a binding minimum wage reduces

employment and creates unemployment.

But in the presence of monopsony power, a binding minimum

wage may simultaneously increase wages and employment.

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Figure 14.5 The Effects of
Legislated Minimum Wages

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 A Final Word

We have learned several explanations for why some

workers get paid more than others, including:
1. workers’ education and skills
2. job characteristics
3. structure of labor markets

APPLYING ECONOMIC CONCEPTS 14.1

Inequality and Shifts in the Labor Market

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 Labor Unions

Labor unions are not as important in the U.S. today than

they have been in the past. Only 7.8% of all private-sector
workers were members of a union in 2005, as compared
to almost 25% in the early 1970s.

LESSONS FROM HISTORY 14.1

Unions in the United States

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Figure 14.6 U.S. Union
Membership by Industry, 2005

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 Collective Bargaining

In collective bargaining, the firm and the union typically

bargain over wages and other working conditions.

The firm usually retains the right to choose the level of

employment.

The more successful a union is at raising wages, the fewer

union members will be employed.

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Union Wage Premium

Unionized workers earn, on average, between 10 and 20

percent higher wages than non-unionized workers with similar
characteristics.

But there is little empirical evidence that firms hire fewer

workers as a result of the higher wages.

Some economists explain this apparent contradiction with the

concept of featherbedding.

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Figure 14.7 The Union
Employment Effect

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Unanswered Questions

Unions may reduce long-run productivity through a process

known as the hold-up of capital.
Much physical capital, once installed, has a very inelastic
supply, and the union may hold up the firm by forcing it to
pay higher wages.
If firms are forward-looking, they will anticipate this behavior,
and might reduce investment.
Lower investment may reduce productivity growth in the
industry.

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Gender and Race in the Labor Market

In 2005, black workers on average earned 70% and Hispanic

workers earned 63% of non-Hispanic whites. Female workers
earned about 69% of what male workers earned.

Possible explanations for the observed disparity:

- differences in education and human capital
- occupational segregation
Policies to eliminate discrimination:
- equal opportunity and access in the workplace
- affirmative action
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Figure 14.8 The Effects of Gender,
Race, and Ethnicity on Income, 2005

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Figure 14.9 The Effect of
Discrimination on Wages

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Policies to Eliminate Discrimination

Prior to the civil rights movement of the 1960s, discrimination

was tolerated and in some cases even promoted.
In the 1960s, two types of policies were introduced to counter
the effects of discrimination:

1. Equal opportunity and access (Equal Pay Act of

1963 and Title VII of the Civil Rights Act

2. Affirmative action policies

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The “Good Jobs–Bad Jobs” Debate

In 1945, the goods-producing sector accounted for 40% of

U.S. employment, and services accounted for less than
50%. Today the numbers are 17% for goods and over 70%
for services.

One concern is that many of the “good jobs” in the

manufacturing sector appear to have been replaced by
“bad jobs” in the service sector.

Is the shift toward services a problem?

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Figure 14.10 Nonfarm
Employment Shares

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Table 14.1 The Importance of
Service-Sector Employment, 2004

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 Five Observations

1. Real income per hour worked has been rising throughout

the past century. As a nation, we are getting wealthier.

2. Low-paying service-sector jobs play an important role in

the U.S. economy, especially for young workers.

3. The fall in manufacturing’s employment share is partly due

to that sector’s dynamism.

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 Five Observations

4. As income grows, demand naturally switches to many

services.

5. Increases in the quality of services lead to rising living

standards.

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A Mixed Blessing?

The transition of workers from agriculture to manufacturing to

services can be difficult for the individuals involved.

This suggests a role for government to maintain the income of

those who are temporarily unemployed.

The goal is to ease such transitions, not block them.

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