1. The Labour Market Chapter 11
LIPSEY & CHRYSTAL
ECONOMICS 12e

2. Learning Outcomes
Some long-lasting wage differentials arise from differences in skills and educational attainments, and some arise from differences in age and gender.
The full characteristics of many of today’s workers are hard to ascertain in advance, so labour market practices evolve to cope with imperfect and asymmetric information.

3. Learning Outcomes
Some wage differentials arise from the type of market in which labour is sold; different wages are likely to be produced by competitive markets, where there are many buyers and sellers.
In monopoly markets, in which unions control the supply, and in markets in which there are so few employers that each has power to influence the outcome.

4. Learning Outcomes
Efficiency wages are above the minimum that would be required to hire a worker as they contain an incentive for the employee to perform well
Selection and management procedures evolve to provide effective monitoring and incentive mechanisms
Internal labour markets within firms are like tournaments in which employees compete for promotion to more senior and better paid jobs

5. INTRODUCTION - THE LABOUR MARKET
Wage Differentials
Equilibrium wage differentials can arise among jobs because [a] each requires different degrees of physical or mental abilities, [b] each requires different amounts of human capital acquired through costly formal education or on-the-job training, [c] some jobs are closed to people who could fill them as a result of discrimination, and [d] the factor markets related to different jobs have different competitive structures.

6. INTRODUCTION - THE LABOUR MARKET
Wage Differentials
In perfectly competitive factor markets, wages are set by demand and supply and there is no unemployment in equilibrium.
In monopolistic markets, wages and employment are less than their competitive levels, but there is no unemployment in equilibrium.

7. INTRODUCTION - THE LABOUR MARKET
If a union enters a perfectly competitive market, it can raise wages above the competitive level at the cost of lowering employment and creating a pool of persons who would like to work at the union wage but cannot.
If a union enters a monopsonistic labour market, it can raise wages and employment to the competitive level.

8. INTRODUCTION - THE LABOUR MARKET
If it raises wages beyond that point, employment will fall.
Unions and professional associations can sometimes restrict the supply of labour and thereby achieve wages above the competitive equilibrium without creating a pool of unemployed.

9. INTRODUCTION - THE LABOUR MARKET
Minimum-wage laws have a similar effect to the setting of wages by unions.
If the market was monopsonistic before the minimum wage is imposed, wages and employment can be raised.
If it was competitive, wages can be raised only at the expense of some (possibly small) reduction in employment in the affected occupation.

10. INTRODUCTION - THE LABOUR MARKET
Heterogeneity, Incentives, and Monitoring Costs
Today’s labour markets are complicated by the fact that brainpower is extremely heterogeneous but it is hard for employers to discern the full characteristics of individual workers.
Many employment contracts are relational contracts, which do not specify in detail what workers have to do.

11. INTRODUCTION - THE LABOUR MARKET
Heterogeneity, Incentives, and Monitoring Costs
This creates the potential for principal-agent problems, where the hired employees act, in part, in their own interest rather than that of the employer.
Solutions to the principal-agent problem involve some combination of incentives and monitoring.

12. INTRODUCTION - THE LABOUR MARKET
Most skilled, managerial, and professional workers now find themselves in an internal labour market that has some of the characteristics of a tournament.
Here the main incentive for lower - and middle-ranking staff is to achieve promotion.
Higher pay generally attaches to more senior jobs, and the competition to gain promotion can be thought of as a tournament.

13. The costs and benefits of formal education
Income earned
L + T L
Age
Direct cost
of education
Net cost of education
Consumer satisfaction

14. The costs and benefits of formal education
Acquiring human capital through formal education beyond minimum school-leaving age implies costs now and benefits later.
Age is plotted on the horizontal axis and income earned on the vertical axis.
Income is zero until age L, which is the minimum school-leaving age.
After that the yellow line, U, shows the income of a typical person who leaves school at age L and takes the relatively unskilled job.
The blue line, S, shows the more complicated stream of payments and income receipts of someone who stays on for T years of formal training after age L.
At first receipts are negative, reflecting the net out-of -pocket expenses related to attending school and university.

15. The costs and benefits of formal education
Deducting the consumption value placed on being at school rather than at work (light yellow area) yields the net cost associated with being in school.
Adding this to the income that could have been earned by going directly into the labour force at age L yields the total cost of the education, which is the medium yellow area.
The benefit is shown by the dark yellow area, representing the difference between the income earned in the skilled lob that is acquired at year L + T (line S) and the income that would have been earned if the labour force had been entered at age L (line U).

16. The costs and benefits of formal education
The investment in human capital could not possibly be worthwhile unless the dark yellow benefit area exceeded the medium yellow cost area.
The net benefit to a particular individual depends on how much he or she discounts the future gain in order to compare it with the immediate costs.

17. Economic DiscriminationDE D0
Wage rate
Wage rate
Quantity of labour
Quantity of labour
[i]. Elite market [E]
[ii]. Ordinary market [O]

18. Economic DiscriminationDE D0 SE
Wage rate
Wage rate E0 w0 E0 w0 q1 q0 q0
Quantity of labour
Quantity of labour
[i]. Elite market [E]
[ii]. Ordinary market [O]

19. Economic DiscriminationDE
S’E D0
S’0 SE E1
Wage rate
Wage rate E0 w1 w0 E0 E1 w0 w2 q1 q0 q0 q2
Quantity of labour
Quantity of labour
[i]. Elite market [E]
[ii]. Ordinary market [O]

20. Economic discrimination, (i) elite market
Market E requires above-average skills.When there is no discrimination, demand and supply are DE and SE.
Initially the wage rate is w0 and employment is q0.
Now let Y-type workers be barred from E occupations.
The supply curve shifts to S’E and the wage earned by the remaining workers, all of whom are type X, rises to w1.

21. Economic discrimination, (ii) ordinary market
Market O requires only ordinary skills. When there is no discrimination, demands and supplies are D0 and S0.
Initially the wage rate is w0 and employment is q0.
Now let type-Y workers be barred from E occupations.
The Y workers put out of work in the E market move to the O market, shifting its supply curve to S’0 .
The wage earned by the workers in the O market falls to w2 .
Because all Ys are forced into the O occupations, their wage is lower than the wages earned in the E market.

22. Figure 15.4 A Monopsonist Facing Many SellersMC S Em wc
Wage rate wm
D = MRP qm qc
Quantity of labour

23. A monopsonist facing many sellers
The competitive wage and employment are wc, and qc.
The monopsonist who must pay the same wage to all equates the marginal cost of hiring labour with labour’s marginal revenue product, which occurs at point Em.
The firm hires qm workers at a wage of wm,. Labour’s income is shown by the dark yellow and dark blue areas enclosed by qm, and wm.
A perfectly discriminating monopsonist can pay each worker his or her supply price, so the S curve is also its marginal cost curve.

24. A monopsonist facing many sellers
The firm will hire qc and pay a total income equal to the dark and medium blue areas under the S curve.
The monoponist's profits are the light yellow area between wm, and wc and the dark yellow area between wm and the S curve. (Under perfect competition both yellow areas are parts of labour’s income.)

25. A Single Union Facing Many EmployersD
Wage rate E1 x w1 E0 w0 q1 q0 q2
Quantity of labour

26. A Single Union Facing Many Employers
Competitive equilibrium is at E0.
The union sets the wage at w1.
This creates a perfectly elastic supply curve of labour up to the quantity q2 which is the amount of labour willing to work at the wage w1.
Equilibrium is at E1 with q1 workers employed and q2 – q1 willing to work at the going wage rate but unable to find employment. Labour income is shown by the blue area.

27. A Single Union Facing a Single EmployerMC S wu x E0 w0
Wage rate wm
MRP = D qm q2 q0
Quantity of Labour

28. A Single Union Facing a Single Employer
The monopsonist facing competitively supplied labour is in the equilibrium with qm, workers employed at a wage of wm,.
If a newly entering union sets its wage at w0, the supply curve runs from w0 to E0 and then rises along the line S.
Equilibrium is at E0 with employment at q0.
If the union seeks a wage higher than w0, it must accept a lower level of employment than q0.
The union can, for example, set a wage at wu, creating a supply curve that runs from wu to x then up the S curve.

29. A Single Union Facing a Single Employer
This yields the same level of employment, qm, as when the monopsonist dominated the market.
But the wage of wu is much higher.
At that wage rate there are q2 - qm people who would like to work but who are unable to find employment.