2. Chapter 15-1 Chapter Fifteen Wage and Employment Determination Under Collective Bargaining Modeified from slides created by: Erica Morrill

3. Chapter 15-2 Chapter Focus  Union behaviour  Interaction between firms and unions  Inefficient production decisions  Inefficient union practices  Bargaining power

4. Chapter 15-3 Theory of Union Behaviour  Unions attempt to maximize objectives given economic constraints  Ability to characterize preferences of unions is difficult

5. Chapter 15-4 Union Objectives  Utility is a positive function of wage rate (W) and employment (E): u(W,E)  Indifference curve is downward sloping  higher wage is needed to compensate for lower employment  Curves have a convex shape  diminishing marginal rate of substitution

6. Chapter 15-5 DLDL Figure 15.1 Union Objectives and Constraints Real Wage Rate WPWP WaPWaP Employment E a2a2 a1a1 U0U0 a3a3 U2U2 a0a0 U1U1

7. Chapter 15-6 Special Cases of Objective Functions  Maximize the Wage rate  indifference curves are horizontal straight lines  Maximize Employment  indifference curves are vertical straight lines  Maximize the (real) wage bill  Indifference curve is downward sloping and convex to the origin (disregards alternative wage rate)  Maximize economic rent  curve out from the intersection of alternative wage  Maximize total union utility: Lu(w)+(N-L)u(Wa).

8. Chapter 15-7 Additional Considerations  Deriving union objectives is simplest when:  preferences are homogeneous  leaders are constrained by democratic decision-making processes  union membership is exogenously determined

9. Chapter 15-8 Monopoly Union Model  Unions negotiate wages taking into account the consequences  The firm decides the employment level  maximizing profits given W set by the union, which yield the demand for labor function, D L.  D L curve is analogous to a budget constraint  Program: Max u(W,E), subject to D L curve  Equilibrium is the tangent of the iso-utility curve and D L curve

10. Chapter 15-9 Firms Iso-profit Curves  Combinations of wage and employment of equal profits, .  Higher profits on lower curves  Firm cannot pay wages below the alternative wage  Wage will lie between the alternative wage rate and the bargaining wage

11. Chapter 15-10 Figure 15.4 The Firm’s and Union’s Preferred Wage-Employment Outcomes E W DLDL U* IuIu  0 =0 W0W0 WuWu ** IfIf W f = W a

12. Chapter 15-11 Relaxing the Demand Constraint  Union’s attempt to alter the constraint in their favor  increasing labour demand (thus increasing E)  making demand more inelastic (thus resulting in higher W and minor job loss)  Restricting substitution possibilities  collective bargaining  influencing public policy  Influence product market  supporting quotas, tariffs and restrictions on foreign competition

13. Chapter 15-12 Efficient Wage and Employment Contracts  Negotiating over wage and employment is mutually advantageous  Pareto-efficient wage-employment outcomes  union’s indifference curve tangent to the firms iso-profit curve

14. Chapter 15-13 Figure 15.5 Efficient and Inefficient Wage- Employment Contracts DLDL A  W E B A’ A’’ C C’ Wa

15. Chapter 15-14 Contract Curve  Locus of the Pareto-efficient wage- employment outcomes  Union cares about wages and employment  CC must lie to the right of D L curve  Firms and unions are better off negotiating an outcome on the contract curve  Moving up on the CC makes unions better off  Moving down makes the firm better off

16. Chapter 15-15 Efficient Versus Inefficient Contracts  Monopoly union model (inefficient)  firm unilaterally sets employment  Contract curve (efficient)  negotiate over wage and employment

17. Chapter 15-16 Figure 15.6 Inefficient and Efficient Contracts E W C’ C DLDL

18. Chapter 15-17 Theory of Bargaining  Predicting the outcome and explaining depend factors  Common features  Bargaining over a set of possible outcomes  Minimum for each party  Voluntary agreement  Neither will agree to an outcome worse than minimum

19. Chapter 15-18 Figure 15.7 The Nash Bargaining Solution F U A N U0 fNfN d T Max V=(U-U0)*(F-F0) The Nash solution F0

20. Chapter 15-19 Solutions to the Sequential Bargaining Problem  Rubinstein’s Theory (sequential bargaining model)  some concepts of non-cooperative game theory  bargainers take turns making offers sequentially  counter offers can be made  utility shrinks in each round (reflecting discount factors)

21. Chapter 15-20 B UBUB fBfB f1f1 f2f2 fRfR URUR R Figure 15.8 The Rubinstein Solution to the Bargaining Problem F U F R U1U1 f1f1 d d f4f4 U0U0 Rubinstein’s Solution Effect of delay Costs U4U4 f3f3 f2f2 f3f3 fRfR URUR U2U2 Bargaining lasts for 3 rounds: u-f-u 3 rd round: u offers U 0 2 nd round: f offers C; 1 st round: u offers R C A Sequence: f-u-f 3 rd round: f offers f B 2 nd round: u offers B; 1 st round: f offers A

22. Chapter 15-21 End of Chapter Fifteen