05. LMEquil (2008)

8/7/2019 05. LMEquil (2008)

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Labor Market EquilibriumLabor Market Equilibrium

Workers prefer to work when the wage is high,Workers prefer to work when the wage is high,and firms prefer to hire when the wage is low.and firms prefer to hire when the wage is low.

Labor market equilibrium ³balance out´ theLabor market equilibrium ³balance out´ the

conflicting desires of workers and firms andconflicting desires of workers and firms and

determines the wage and employment observeddetermines the wage and employment observed

in the labor market.in the labor market.

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1. Equilibrium in a Single Competitive Labor Market1. Equilibrium in a Single Competitive Labor Market

The supply curve gives theThe supply curve gives the

total number of employeetotal number of employee--hours that agents in thehours that agents in theeconomy allocate to theeconomy allocate to themarket at any given wagemarket at any given wage

level; the demand curvelevel; the demand curvegives the total number of gives the total number of employeeemployee--hours that firmshours that firmsin the market demand atin the market demand atthat wage. Equilibriumthat wage. Equilibriumoccurs when supply equalsoccurs when supply equalsdemand, generating thedemand, generating thecompetitive wagecompetitive wage ww * and* andemploymentemployment E E *.*.

Equilibrium in a Competitive Labor Market

Employment

Dollars

E*

W*

D

S

Note: There is no unemployment in a

competitive labor market. Persons

who are not working are also not

looking for work at the going wage.

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2. Competitive Equilibrium Across Labor Markets2. Competitive Equilibrium Across Labor Markets

The economy typically consists of many labor markets, even for

workers who have similar skills. As long as either workers or firmsare free to enter and exit labor markets, a competitive economy will

be characterized by a single wage.

Dollars

Employment

D N

S¶ N

W*

Dollars

Employment

DS

S¶S

W*

S N

W N

SS

WS

Competitive Equilibrium in Two Labor Markets Linked by Migration

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Note: The ³single wage´ property of Note: The ³single wage´ property of competitive equilibrium has importantcompetitive equilibrium has importantimplications for economic performance. Thatimplications for economic performance. Thatis, workers of given skills have the same valueis, workers of given skills have the same valueof marginal product of labor in all markets.of marginal product of labor in all markets.The allocation of workers to firms whichThe allocation of workers to firms whichequates the value of marginal product acrossequates the value of marginal product across

markets is also the allocation which maximizesmarkets is also the allocation which maximizesnational income. This type of allocation isnational income. This type of allocation iscalled ancalled an efficient allocationefficient allocation..

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3. Policy Application: Payroll Taxes3. Policy Application: Payroll Taxes

Payroll taxes on employers are heavily used in thePayroll taxes on employers are heavily used in thesocial insurance area. With our simple labor model,social insurance area. With our simple labor model,we can show that the party making the socialwe can show that the party making the socialinsurance payment is not necessarily the one thatinsurance payment is not necessarily the one that bears the burden of the tax. bears the burden of the tax.

Tax

Employment

S0

D0

D1

R eal Wage

E0E1

E2

W1

W0

W1+X

W0+

Tax is a fixed dollar amountX

.D0D1

with vertical distance of X.

pt. A: excess supply real wage

Employees bear part of the burden of the

payroll tax in the form of lower wage

rates and lower employment levels.

Note: In general, the extent to which the

labor supply curve is sensitive to wages

determines the proportion of the employer

payroll tax that gets shifted to employee¶s

wages.

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4. The Cobweb Model4. The Cobweb Model

Our analysis of labor market equilibrium assumes that marketsOur analysis of labor market equilibrium assumes that marketsadjust instantaneously to shifts in either supply or demandadjust instantaneously to shifts in either supply or demand

curves, so that wages and employment change swiftly from thecurves, so that wages and employment change swiftly from the

old equilibrium levels to the new equilibrium level. Manyold equilibrium levels to the new equilibrium level. Many

labor markets, however, do not adjust so quickly to shifts inlabor markets, however, do not adjust so quickly to shifts in

the underlying supply and demand curves.the underlying supply and demand curves.

Example: the Engineering MarketExample: the Engineering Market

Note: The adjustment of college enrollments to changes in the Note: The adjustment of college enrollments to changes in the

returns to education is not always smooth or rapid, particularlyreturns to education is not always smooth or rapid, particularly

in fields that are highly technical.in fields that are highly technical.

The inability to respond immediately to changed market The inability to respond immediately to changed market

conditions can cause boomconditions can cause boom--andand--bust cycles in the market for bust cycles in the market for

highly technical workers.highly technical workers.

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Wage

Number of Engineers

D¶

S

D

N0 N2

N3 N

1

W2

W0

We

W3

W1

Demand increase to D¶; temporary supply is N0. W increase to W1

W1

wage induce increase in supply to N1 excess supply

W reduce to W2

W2

wage reduce supply to N2

W increase to W3

at W3

, supply increase to N3

excess supply W reduces, etc.

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Overtime the swings become smaller and eventuallyOvertime the swings become smaller and eventually

equilibrium is reached. cobweb model.equilibrium is reached. cobweb model.

Note: There are two key assumptions in the cobweb model: Note: There are two key assumptions in the cobweb model:

1.1. It takes time to produce new engineers, so thatIt takes time to produce new engineers, so thatthe supply of engineers can be thought of asthe supply of engineers can be thought of as

being perfectly inelastic in the short run. being perfectly inelastic in the short run.

2.

2. Students are very myopic when they areStudents are very myopic when they areconsidering whether to become engineers.considering whether to become engineers.

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5. Policy Application: The Impact of Minimum Wages5. Policy Application: The Impact of Minimum Wages

The standard economic model of the impact of The standard economic model of the impact of

minimum wages on employment is illustrated in theminimum wages on employment is illustrated in thefollowing figure:following figure:

Dollars

E*

W*

D

S

ES

W

E

The Impact of the Minimum Wage on Employment

Note: A minimum wage

creates unemployment

both because some previously employed

workers lose their jobs,

and because some workers

who did not find it

worthwhile to work at the

competitive wage find it

worthwhile to work at the

higher minimum wage.Employment

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The Covered and Uncovered Sectors

Dollars

EC

W*

DC

SC

W

EmploymentE

(a) Covered Sector

The Impact of Minimum Wages on the Covered and Uncovered Sectors

Dollars

EU

W*

DU

SU

Employment

(b) UNcovered Sector

S¶U

S´U

E¶UE´U

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Note: In the absence of a minimum wage, the Note: In the absence of a minimum wage, themigration of workers across sectors equates themigration of workers across sectors equates the

wage in the two sectors. The migration of wage in the two sectors. The migration of

workers when the wage in one of the marketsworkers when the wage in one of the markets

is set at the minimum wage equates theis set at the minimum wage equates the

expected wage across sectors. I.e., the freeexpected wage across sectors. I.e., the free

migration of workers across sectors ensure thatmigration of workers across sectors ensure that

the expected wage in the covered sector equalsthe expected wage in the covered sector equalsthe for the for--sure wage in the uncovered sector.sure wage in the uncovered sector.

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6. Noncompetitive Labor Markets6. Noncompetitive Labor Markets

(1)(1) MonopsonyMonopsony

Because the firm is the only demander of labor inBecause the firm is the only demander of labor in

this market, it can influence the wage rate.this market, it can influence the wage rate.

Monopsnoists face an upwardMonopsnoists face an upward--sloping supply curve.sloping supply curve.

This is because the supply curve confronting themThis is because the supply curve confronting them

is the market supply curve.is the market supply curve.

Note: To expand its work force, a monopsonist must Note: To expand its work force, a monopsonist mustincrease its wage rate, i.e., the marginal cost of increase its wage rate, i.e., the marginal cost of

hiring labor excess the wage.hiring labor excess the wage.

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To maximize profits, we know that any firm should hire

labor until the points at which marginal revenue product

equals marginal cost.MR P = MCL

W

L

MR P

S

MCL

Em Ec

Wm

WC

Wages are below marginal

revenue product for a

monopsonist.

Wm

< WC

and Em

< EC

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(2)(2) MonopolyMonopoly

A monopoly trying to maximize profits and facing aA monopoly trying to maximize profits and facing a

competitive labor market will hire workers until itscompetitive labor market will hire workers until itsmarginal revenue product equals the wage rate:marginal revenue product equals the wage rate:

MR P = (MPMR P = (MPLL)(MR ) = W)(MR ) = W

(MR/P)(MR/P)(MP(MPLL) = (W/P)) = (W/P)<1<1

The demandThe demand--for for--labor curve for a firm that haslabor curve for a firm that hasmonopoly power in the output market will lie belowmonopoly power in the output market will lie below

and to the left of the demandand to the left of the demand--for for--labor curve for anlabor curve for anotherwise identical firm that takes product prices asotherwise identical firm that takes product prices asgiven.given.

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Note: The wage rates that monopolies pay are not necessarily

different from competitive levels even though employment levels

are. An employer with a product market monopoly may still be a

very small part of the market for a particular kind of employee, and

thus be a price taker in the labor market even though a price maker

in the product market.

Employment

Dollars

The Labor Demand of a Monopolist

VMPE

MR PE

WA

Em E*

05. LMEquil (2008)

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