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Chapter 9 (2) - The labour market: wages, profits and unemployment -…
Chapter 9 (2) - The labour market: wages, profits and unemployment
Unit 7
as the cost (C) has fallen, at every point on the isoprofit curve is now at a higher profit level than was the case prior to the decline in wages.
Importantly, it is also steeper than before. Recall that the slope of the isoprofit curve is (p − C)/q so that for example, at point B (q, p) the slope of the isoprofit curve with the lower wage is steeper.
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firms are often reluctant to cut nominal wages because it may reduce worker morale and result in conflict with employees. Strikes and worker resistance such as informal ‘go slow’ tactics would disrupt the production process.
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For the individual firm, a fall in price leads to higher sales. But falling prices across the economy can lead to cutbacks in spending, which shift the demand curves facing firms to the left.
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Falling prices can lead households to postpone spending, as they hope to get better bargains later.
Imagine the economy was at point B then the following sequence would take place, initiated by HR:
- Lower wages would lower costs.
- The degree of competition facing the firm has not changed, so it would want to set a price to restore the profit-maximizing markup.
- Given the lower costs, firms would therefore cut prices.
- Because the demand curve facing the firm is downward-sloping they would sell more, expanding output and employment.
as wages fall people may spend less, reducing demand.
With such high unemployment, we could pay our workers much less and they would still do their work!’ Because the firm could make higher profits by lowering the wage, as long as it remained above the wage-setting curve, B is not a Nash equilibrium.
Thus, in the presence of deficient aggregate demand, the usual profit-seeking decisions of firms and the responses of consumers, when added up across the economy, cannot be guaranteed to move the economy from B to the Nash equilibrium at X.
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An unemployed person at point B is also involuntarily unemployed. In fact, such a person would accept a job with a wage below the wage shown at B, and still be willing to work hard on the job.
Rather than either waiting for a revival in aggregate demand (for example, through a recovery in global demand for minerals) or waiting for the process of wage and price reductions to spread across the economy, the government can increase the level of aggregate demand.
An unemployed person at X is involuntarily unemployed because that person would accept a job at the real wage shown by the intersection of the wage and price-setting curves.
One method is for the central bank to make borrowing cheaper by reducing the interest rate. (monetary policy) Other methods are for the government to increase its spending or reduce tax rates. (fiscal policies)
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The increase in unemployment caused by the fall in aggregate demand is called ‘demand-deficient’ unemployment or cyclical unemployment.
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Aggregate demand, for example, is the sum of the demand for all of the goods and services produced in the economy, whether from consumers, firms, the government, or buyers in other countries.
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Economists use the term aggregate—meaning added up to measure the whole, not just the parts—to describe economy-wide facts or variables.
The adjustment via fiscal or monetary policy is shown in Figure 14, the adjustment via wage and price cuts is shown in Figure 15, and the aggregate labour market is shown in Figure 16
The term ‘derived demand for labour’ is used to highlight the fact that the firms’ demand for labour depends on the demand for their goods and services.
Unit 10
Workers will now be working harder, but wages increase by more than productivity, so firms receive less effort for each dollar spent on wages.
It follows that profits will be lower than without the union, that is, on the flatter isocost line passing through C.
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To see the difference that a labour union makes, let’s see how the labour market would work if instead of the employer setting the wage and the employees individually responding, the process would now be:
- The union sets the wage.
- The employer informs workers that insufficient work will result in job termination.
- Employees respond to the wage and the prospect of dismissal by choosing how hard to work.
Looking at the equilibrium where the bargained wage-setting curve intersects with the price-setting curve, the wage is unaffected, but the level of employment is lower.
The relative bargaining power of the union and the employer determines how much this bargaining curve lies above the wage-setting curve.
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Where workers are organized into trade unions, the wage is not set by HR but instead is determined through a process of negotiation between union and firm.
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the fraction of the workforce employed under collective bargaining agreements negotiated by labour unions varies greatly across countries
The employer’s recognition of the trade union, and its willingness to compromise with them over a higher wage, as a sign of goodwill.
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As a result, they might identify more strongly with their firm and experience effort as less of a burden than before, shifting their best response curve in Figure 24 up.
The result of the greater bargaining power of the workers, and their reciprocation of the company’s worker-friendly policy, is shown as point D
A trade union is an organization that can represent the interests of a group of workers in negotiations with employers over issues such as pay, working conditions, and working hours.
We have shown two effects of the presence of a labour union, which we can now represent in the labour market diagram:
- It may be able to get the firm to pay a wage greater than the minimum necessary to induce the employees to work (the bargaining curve is above the wage-setting curve).
- Providing employees with both recognition and a voice in how decisions are made may lower the disutility of effort and thus reduce the lowest wage necessary to motivate employees to work effectively.
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In this figure, we show the case in which the equilibrium level of employment is higher and unemployment lower with the union (point Y) than without (point X). This is because the second effect (called the ‘union voice effect’) that shifts the wage-setting curve down was greater than the bargaining effect that shifts the wage-setting curve up.
Unit 11
the unemployment rate is held constant at 12% and we vary the unemployment benefit to which the worker is entitled.
A higher unemployment benefit increases the reservation wage and shifts the best response curve to the right: the higher reservation wage at a higher unemployment benefit level is shown by point G.
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The markup chosen by the firm when it sets its price to maximize its profits is determined by the amount of competition that the firm faces, so it is unaffected by the increase in productivity.
Other policies affecting the supply of labour include policies to enhance women’s employment opportunities such as subsidized childcare, and a reduction in discrimination against disadvantaged minorities.
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Unit 13
Where unemployment is raised above the equilibrium level because of a lack of aggregate demand, governments and central banks can use fiscal and monetary policies to reduce it.
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Unemployment can be higher than equilibrium unemployment as a result of a fall in the economy-wide demand for goods and services.
In the labour market equilibrium there will be some people involuntarily unemployed, seeking a job and willing to work at the going wage rate.
Involuntary unemployment at labour market equilibrium is unavoidable, because:
- Employers and workers have a conflict of interest: This is over how hard employees work.
- Employers cannot write a complete contract with their employees: They cannot specify the quality and quantity of work effort they will receive.
Unit 8
Therefore the shaded area in the figure—and hence inequality measured by the Gini coefficient—will increase if:
- A larger fraction of the employees are without work (higher unemployment rate): The first kink shifts right.
- The real wage falls (or equivalently, the markup rises) and nothing else changes: The second kink shifts down.
- Productivity rises and nothing else changes (real wages do not rise): This implies that the markup rises, so again the second kink shifts down.
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The fraction of output received in wages, called the wage share in total income, s, is:
𝑠=wage share
=real wage per worker day / output per worker day
=𝑤 / 𝜆
In Figure 18 we see what would happen if there was an increase in the degree of competition faced by firms, perhaps as a result of a decrease in the barriers to firms from other countries competing in this economy’s markets.
The size of the shaded area measures the extent of inequality, and the Gini coefficient is 0.36.
The markup would decrease, and as a result the real wage shown by the price-setting curve would increase, leading to a new equilibrium at point B with a higher wage and a higher level of employment. The share of output going to profits falls, and the share going to wages rises.
The price-setting curve in the left panel indicates that total output is divided up so that workers receive a 60% share and their employers receive the rest. In the right panel this is shown by the second ‘kink’ in the Lorenz curve, where we see that the poorest 90 people in the population receive 60% of the total output
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Because the unemployed people receive no income if there are no unemployment benefits, the Lorenz curve (the solid blue line) begins on the horizontal axis to the right of the left-hand corner.
The Gini coefficient is equal to the area A divided by the area under the 45-degree line, and so it is equal to A/0.5 = 2A. We calculate A as 0.5 – B where B = B1 + B2 + B3:
𝐵1=1 / 2 x 𝑛𝑠
𝐵2=(1−𝑢−𝑛)𝑠
𝐵3=1 / 2 x (1−𝑢−𝑛)(1−𝑠)
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Rearranging these variables gives us:
𝐵=𝐵1+𝐵2+𝐵3
=1 / 2 x 𝑛𝑠+(1−𝑢−𝑛)𝑠+1 / 2 x (1−𝑢−𝑛)(1−𝑠)
=1 / 2 x (1−𝑢−𝑛)+1/ 2 x (1−𝑢)𝑠
The economy is in equilibrium at point A, where the real wage is both sufficient to motivate workers to work and consistent with the firm’s profit-maximizing price markup over costs (w = 0.6 in this case).
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In the left panel of Figure 17 we show the labour market of an economy with 80 identical employees of 10 identical firms. As you can see, there are 10 unemployed people. Each firm has a single owner.
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If the class of employers gets relatively smaller: Then u + n rises. This implies that g rises, and point Y shifts right on the Lorenz curve: inequality goes up.
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An increase in the wage share w/q, ceteris paribus, will reduce the Gini coefficient: This shifts point Y upwards.
So the labour market model is also a model of the distribution of income in a simple economy in which there are just these two classes, where some of the latter are without work.
If all firms are cooperatives then the Gini coefficient declines. This assumes productivity remains unchanged.
The labour market model determines the level of employment, unemployment, and the wage rate, the division of the economy’s output between workers (both employed and unemployed) and employers.
Unit 12
We use Pareto efficiency: This concept evaluates whether there is some other outcome in which all parties might have done better (or at least as well).
Recall from Unit 8 that i there were no unexploited opportunities for mutual gain at the competitive equilibrium. In this situation, it is not possible to make one of the buyers or sellers better off. The outcome therefore was Pareto efficient.
We use the Nash equilibrium: This concept helps us predict what outcomes we will observe when people interact.
Competition among many buyers (firms hiring employees) and sellers (people seeking work) results in an equilibrium outcome—the wage w and the level of employment N—that is not Pareto efficient. What this means is that there is some other outcome that both employers and employees would prefer.
Because it is the employee’s work that produces the firm’s goods and is essential to the firm’s profits, this means the contract is an incomplete contract: something that matters to one of the parties to the exchange is not covered in the contract.
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in the labour market, the employment contract is usually for the employee’s work time and not for the work itself.
The bread market tends to be a one-off interaction among virtual strangers, while the labour market is an ongoing interaction among people who not only know each other’s names but also care about what the other person is like.
From unit 6 we saw that employers choose a wage to balance their wage costs against the positive effects that a higher wage has on the employee’s motivation to work.
Another major difference is that the supervisor directs what the barista does with the expectation that she will comply with his orders. Because she receives an employment rent which she would lose if he were to dismiss her, he can exercise power over her, getting her to do things that she might not do without the threat of dismissal.
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This is not the case in the bread market. If the buyer complains about the baker’s attire, he would be invited to shop elsewhere.
Now think about a buyer in the labour market. This is an employer who buys the employee’s time.The price is the wage.
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Unit 9
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The labour supply curve would shift to the right, as shown in figure 19
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We summarize the effects of the increase in labour supply on the labour market:
- The shift downward in the wage-setting curve at the initial level of employment lowered the wage (to B).
- The reduction in the wage results in a reduction in the firms’ marginal costs and with no change in the firm’s demand conditions, the firms will hire additional workers.
- As a result, employment expands so that once again the economy is at the intersection of the price-setting curve and the new wage-setting curve, with higher employment.
- The increase in labour supply leads to a new equilibrium at higher employment because it shifts the wage-setting curve down. New hiring stops when the wage is once again at the level shown by the price-setting curve (at C). In the new equilibrium, employment is higher and the real wage is unchanged.
Imagine that there is immigration of people looking for employment or that people who have stayed at home to raise children, or have retired, re-join the labour force. Let’s look first at what happens to the wage-setting curve following an increase in labour supply:
- new jobseekers would enter the pool of unemployed
- which would increase the expected duration of a spell of unemployment
- by raising the cost of job loss, this increases the employment rent enjoyed by employed workers at the current wage and level of employment
- but firms would then be paying more than necessary to ensure worker motivation on the job
- therefore firms would lower their wages