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Market Equilibrium (Perfect competition (Adjustment Costs (Asymmetric…
Market Equilibrium
Perfect competition
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Cobweb Model
Assumptions
- Time is needed to produce skilled workers
- People decide to become skilled workers by looking at the conditions (the wage) in labour market at the time they enter school
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Adjustment Costs
Asymmetric variable costs: Changing employment is costly, and the costs increase at increasing rate. If government policies prevent firms from firing workers, costs of trimming the workforce will rise faster than costs of expanding the firm.
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In other words, under Adjustment Costs model, there are costs of changing the employment level. This encourages firms to adjust the employment level slowly.
If workers are mobile, and there are no costs with entry/exit of labour market, there will be a single wage paid to workers.
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Monopsony
Firm is the only buyer of labour: firm faces the entire labour supply, and can set up wage
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2 types of monopsonist firms:
- Perfectly discriminating
- Non-discriminating
Perfectly discriminating
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To maximise profits, monopsonist perfectly discriminates by paying each worker his/her own reservation wage.
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All surplus goes to the firm. There is no distortion, but there is massive inequality (as workers do not get any surplus)
Non-discriminating
Pays all workers the same wage, regardless of reservation wage
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To attract more workers, must raise the wage of all workers
Impact of minimum wage on non-discriminating monopsonist
See slides for diagram!
- Minimum wage imposed on a non-discriminating monopsonist can increase employment and wages
- Adverse effects of minimum wage are mitigated in this circumstance
Monopoly
Firms that have monopoly power can influence the price of the product they sell; they face the entire demand for the output they produce
(Non-discriminating) monopolist faces downward-sloping demand curve for its output and even lower downward-sloped MR curve
(Non-discriminating) monopolist:
- MR lies below VMPE (MR<VMPE)
- Employment level lower than competitive level of employment
Why is employment level lower than competitive level of employment?
- If the monopolist hires more workers, it is true that the monopolist is able to produce more output
- Due to downward-sloping demand curve, higher output would then be sold be lower price
- Thus, monopoly refrains from hiring more workers in order to restrict output quantity and not have to drive prices down
Efficiency
- Pareto efficiency exists when all possibles gains from trade have been exhausted
- When state of the world is Pareto efficient, to improve one person's welfare necessarily requires decreasing another's welfare
- Pareto improvement = can a change make anyone else better off without making someone worse off?