Topic 4.1 Outcomes in a Single Market. Professor H.J. Schuetze Economics 370

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1 Topic 4.1 Outcomes in a ingle Market Professor H.J. chuetze Economics 370 upply and emand Let s put labour supply and demand together to look at ho ages and employment might be determined eoclassical model assumes perfect competition in the input and output markets Workers are homogeneous Jobs are homogeneous e.g. might think of the market for accountants in Victoria Professor chuetze - Econ

2 upply and emand uch a market can be depicted as follos eloitte and Touche mith, mith and Jones Total Market * 1 * 2 * d d = d 20 n 10 n 30 emand in each firm is simply the MRP otice that the elasticities need not, and likely ouldn t, be the same in the to firms The market demand curve is the horizontal sum of all of the firms demand curves Professor chuetze - Econ upply and emand eloitte and Touche mith, mith and Jones Total Market * 1 * 2 * d d = d 20 n 10 Each of the firm s labour supply curves is horizontal at the going age Wages are the same in all firms and markets Each firm s demand for accountants is determined by the intersection of demand and supply The market age is determined by the intersection of aggregate demand and supply n Professor chuetze - Econ

3 Adjustments to Long-Run Equilibrium There are situations in hich e still might expect to see differences in ages across firms and markets in this neoclassical setting hort-run ynamic Adjustment: The previous model is really a long-run analysis Assumes firms can get all the labour they need at the going age In the short-run the firm may still have to raise ages to attract orkers e.g. - orkers have to move from other province - orkers have to complete training Professor chuetze - Econ Adjustments to Long-Run Equilibrium s c In this case, the firm s short-run labour supply curve may be upard sloping oftare Engineers s s uppose there is an increase in the demand for labour (- ) uch as that experienced recently by softare engineers In the short-run the firm may have to increase the age to meet the increased demand Overtime premium Attract orkers from other firms In the long-run the supply of orkers ill likely increase because of the relatively high age Professor chuetze - Econ

4 Adjustments to Long-Run Equilibrium The adjustment takes time Why? Workers may have to move Workers may have to obtain training etc. o, temporary differences in ages ithin homogeneous jobs across firms or local labour markets are consistent ith the neoclassical model Professor chuetze - Econ Implications of the eoclassical Model As e have noted, the long-run equilibrium is characterized by the familiar supply and demand analysis W* * Market forces move the market toards the equilibrium age and quantity of labour exchanged What are the implications of this model? 1. Wages are equalized across homogeneous orkers and homogeneous firms - o incentive for firms to pay a higher age as this ill not affect productivity - This does not imply that ages on t vary across different orkers or across different firms Professor chuetze - Econ

5 Implications of the eoclassical Model 2. There is no involuntary unemployment - o individuals that ould like to ork at the going age ho are unable to find ork - Only individuals ho ould not ork at the going age (but ould at higher ages) are unemployed 3. There are no queues to ork for certain firms - All firms are the same in terms of orking conditions, job security, etc. - o reason to orry about hich firm you ork for In many ays, the predictions of the competitive model of labour demand do not accord ith observed labour market behaviour Professor chuetze - Econ epartures from the eoclassical Model Many of these inconsistencies can be explained by alloing for: i) Imperfect Competition ii) Imperfect Information iii) Risk and Uncertainty iv) A long-run relationship beteen firms and orkers In this section e ill look at ho the basic model changes hen e allo for i) and ii) above Professor chuetze - Econ

6 i(a). Imperfect Competition - Monopoly Let s start by alloing for imperfect competition in the product market uppose that there is a single firm selling in the product market but competition in the input markets Thus, the firm s demand curve for it s output is no longer horizontal at the price Instead, it is the industry demand curve The structure of the product market has implications for the labour market because labour demand is derived from output Professor chuetze - Econ Monopoly To see this e need only to look at the labour demand equation Competition: MP P = * This is because ith competition MR=P For the monopolist output price is not fixed Monopoly: MP MR = * o, as the monopolist expands output (labour) not only does MP fall so does the MR of output Recall: ith no price discrimination P MR Q The monopolist must loer price to increase sales MR also falls Professor chuetze - Econ

7 Comparing Competition and Monopoly uppose the industry is initially competitive To get industry demand simply sum all of the individual firm s labour demand curves Compare this to the case here all of the firms form a cartel and operate as a monopolist * C = MP P= MRP M =MP MR=MRP The labour demand curve for the cartel (monopolist) lies belo the competitive industry emand is loer because the cartel ill reduce output and increase the product price M * C * At a given age, therefore, labour demand is loer under monopoly (e.g. at *) Professor chuetze - Econ Comparing Competition and Monopoly The monopolist s elasticity of labour demand ill be less than that of a competitive industry Because MR and MP both fall, as the monopolist increases output () the MRP falls faster epartures from Market Wages: Continuing to assume perfectly competitive input markets, alloing for monopoly does not appear to have much of an impact on ages We get a similar outcome to competition As long as there is competition in input markets all firms are price takers and pay the market age Professor chuetze - Econ

8 epartures from Market Wages There are a number of reasons, hoever, that monopolist s ages might deviate from ages paid by competitive firms for similar orkers 1. Monopolists earn economic profits This may imply that monopolists ill be more flexible in age negotiations Unions may negotiate to share in the monopolist s profits 2. Monopolists tend to be large firms It tends to be more costly to monitor orkers May pay a higher age to prevent shirking Large firms usually have rigid ork schedules and unpleasant orking conditions Professor chuetze - Econ epartures from Market Wages ome of the characteristics of a monopolist might also allo for loer than average ages Profits may allo monopolists to hold out longer against age demands and strikes Larger firms tend to provide greater employment security and lots of opportunity for advancement Hoever, a competitive labour market might not ensure a ceiling on ages but ill ensure that there is a floor on ages This implies an upard bias on ages in monopoly sectors along ith an excess supply of orkers imilar arguments can be made for ages in sectors ith other forms of imperfect competition Professor chuetze - Econ

9 i(b) Imperfect Competition - Monopsony In a prior topic e examined the case of Monopsony Recall that Monopsony implies that there is imperfect competition in the labour market but competition in the output market e.g. one firm purchasing labour in the input market In the case here firm s ere unable to price discriminate e sa that ages and marginal revenue product need not equate Let s no look at a special case of monopsony that yields an equilibrium in hich equally skilled orkers are paid different ages Professor chuetze - Econ Imperfectly-iscriminating Monopsonist In this case the monopsonist is able to pay groups of homogeneous orkers different ages Example, able to pay men and omen differently because of differences in reservation ages To conditions must be satisfied for imperfect monopsonistic discrimination to exist 1. The existence of separate markets for the different types of orkers 2. ifferences in the supply elasticities for the to markets that make it orthhile for the firm to differentiate Professor chuetze - Econ

10 Example: ex iscrimination uppose that men and omen are equally productive (one MRP curve) But that omen face poorer employment prospects (loer reservation ages) MC m m upply curve of omen lies belo that of men MC Elasticity of labour supply is loer for omen In both cases, MC lies above the supply curve MRP Professor chuetze - Econ Total Marginal Cost Total MC (MC T ) gives the total amount of labour for a given marginal cost To get total MC e must horizontally sum the to MC curves MC m At lo levels of employment the m firm hires only omen because MC of the relatively lo MC MC T Total MC = MC curve of omen At k the MC of the marginal oman exactly equals the MC of the first man MRP Beyond k, the firm ill start hiring men along ith omen k Thus, MC T becomes a eighted average of the MC curves of men and omen beyond k Professor chuetze - Econ

11 Equilibrium MC* m MC m m MC MC T The firm ill hire orkers up to the point here MRP =MC T Total employment = T A the optimum MCm=MC=MC* T = the employment of men m + the employment of omen MRP m T The firm hires a mix of men and omen even though the supply curve of omen is loer than men s This is because the MC of hiring the 10 th or 11 th oman may be higher than the 1 st man Wages for men and omen are read off of the relevant labour supply curve Professor chuetze - Econ More on Wages MC m MC* m m MC MC T MRP otice that, even in equilibrium, ages are higher for men This is not because men are more productive than omen Women in this example face poorer outside opportunities m T This can help to explain hy e might see a persistent differential in male and female ages This is contrary to the perfectly competitive model Even here, hoever these differentials may not persist Competition should force the breakdon of segmentation and improve omen s outside opportunities Professor chuetze - Econ

12 ii. Imperfect Information - Efficiency Wages The basic idea behind the efficiency age model is that firms might be illing to pay higher than market ages to increase productivity e.g. could improve orker morale and prevent shirking because of the high cost of being fired Firms might also pay higher ages to stave off unionization or to attract high quality applicants Whether a firm offers an efficiency age depends on: 1. Costs of monitoring orkers 2. The impact on production of shirking 3. The cost of orker turnover (training costs) 4. Ho credible the threat of unionization is Professor chuetze - Econ Efficiency Wages Let s start ith a situation in hich there are no monitoring costs or perfect information about orker s effort Wage W* Competitive market ith no shirking Labor supply curve is inelastic Wage equals * ith E orkers E Employment Professor chuetze - Econ

13 Efficiency Wages With shirking (high costs of monitoring) the firm ill offer higher ages to encourage orkers not to shirk What age/employment should the firm offer? epends on the unemployment rate (shirking cost) High Unemployment: Very costly for orkers to shirk - face long unemployment spell Firm can attract non-shirking employees ith a small premium Lo Unemployment: Lo costs to shirking - easy to find another job Firm must pay high age to encourage non shirking Professor chuetze - Econ Efficiency Wages Thus, the no-shirking supply curve is given by Wage G Gives the number of non shirking orkers that firms can hire at each age W* F Employment At F: employing fe orkers of the total (E) (high unemployment) Firm can attract non shirking orkers at a lo age At G: lo unemployment Firms must pay high ages to encourage orkers not to shirk Professor chuetze - Econ

14 Efficiency Wages ote: The no shirking supply curve never touches the perfectly inelastic supply curve 0 unemployment implies no costs to shirking Unemployment is given by the difference beteen the to supply curves ome unemployment is necessary to keep employed orkers in line Professor chuetze - Econ Equilibrium The equilibrium is given by the intersection of demand and the no-shirking supply curve Wage The age is W and the number of orkers is As e might expect there W is unemployment even in equilibrium (- ) W* Employment The unemployment experienced is involuntary because these orkers are illing to ork at the current age Firms ill not hire these orkers because 0 unemployment encourages shirking Professor chuetze - Econ

15 ual Labour Markets There is the possibility of a dual labour market arising This is the case if there is another market sector in hich firms do not ish to pay efficiency ages Wage ector A Wage ector B B W W* W* 0 A 0 B Here labour is homogeneous and there are to labour sectors Without efficiency ages the equilibrium has both sectors paying the same age (*) and hiring 0 orkers Professor chuetze - Econ ual Labour Markets Wage ector A Wage ector B B B W W* W* W B A 0 B 0 With efficiency ages paid in sector A, employment in sector A falls as the age rises As orkers are shifted out of sector A labour supply in sector B increases This loers ages and increases employment in sector B A dual labour market is created in hich one sector has high ages and the other sector has lo ages even though orkers are homogeneous 1 B Professor chuetze - Econ

16 Evidence It is difficult to test the efficiency age theory because the neoclassical model also implies a relationship beteen productivity and ages Blanchfloer and Osald (1994): The age curve Find a negative relationship beteen unemployment and age rates Remarkably this relationship holds in many markets around the orld Consistent ith the efficiency age model The higher the rate of unemployment the loer the age firms must offer to prevent shirking Professor chuetze - Econ