Chapter 12 Labour Market Applications

1
Chapter 12Labour Market Applications
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Minimum Wage Legislation

• The real question regarding minimum wage
  legislations is, do they help the working poor?
• Does it achieve a desired redistribution of
  income?
• Are workers in the industry better-off?
• Whose income falls to make up for the rise in
  minimum wage income?
• Is inefficiency an invariable side effect?

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Figure 12.1 Minimum-wage legislation in a
competitive labour market
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Minimum Wage in a Competitive Labour Market

• In a competitive market, inefficiency is a
  necessary by-product of an effective minimum wage
  law.
• As labour services are no longer put to their
  most productive uses, either unemployment or
  underemployment will signal that inefficiency.
• Underemployed workers in Figure 12.1 are those
  who have a marginal product of 12 in this
  industry, but choose to work in a less productive
  industry rather than face the chance of
  unemployment.

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Monopsonistic Labour Markets

• A monopsonistic labour market has a single buyer
  of labour.
• The implications of minimum-wage legislation are
  very different compared to a competitive market.
• Figures 12.2 and 12.3 illustrate why this is the
  case.

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Figure 12.2 Minimum wage and a monopsonists
marginal factor cost
7
From Figure 12.2

• Once a minimum wage is brought into a monopsony,
  the marginal factor cost (MFC) will change.
• The monopsonists pre-legislation MFC is the line
  segment DBC.
• The post-legislation MFC is now two lines, wA
  and BC.

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From Figure 12.2

• If the monopsonist hires an amount of labour less
  than z, its MFC is w.
• If it hires beyond that point, its MFC is segment
  BC of its original MFC function because it can
  hire additional workers only at a wage rate
  higher than w.

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Figure 12.3 Minimum wage and monopsony
10
From Figure 12.3

• Does a minimum wage increase workers incomes?
• Yes. As long as the wage is not higher than w,
  some workers are better off and none worse off.
  Why?
• - At w or below, it has no effect.
• - At above w but below w, workers hired
  before the introduction of the minimum wage
  will be paid more and new workers will be hired
  at the new (minimum) wage.
• - If the rate is w, no new workers are hired,
  but existing workers will be paid more.

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Minimum Wage Legislation

• The attractiveness of minimum wage legislation
  depends upon whether labour markets are
  competitive or monopsonistic.
• Empirical evidence suggests that labour markets
  covered by minimum wage laws are competitive, and
  the laws are problematic.

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Minimum Wage Legislation

• Workers who remain employed are better off. It is
  not clear at whose expense the gain is made (we
  do not know who pays).
• By creating unemployment and underemployment, the
  legislation will hurt some people it was intended
  to help.

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Union Wage Rates

• Although analyzing the economic consequences of
  unionization objectively is not easy, we can move
  in that direction by adapting our minimum-wage
  analysis to apply to union wages rates.
• In this analysis, the union wage is treated like
  a wage floor - setting a minimum wage paid in a
  unionized industry.

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Figure 12.4 A wage floor in the two-sector model
of the labour market
15
From Figure 12.4

• Imposing the wage floor means that some workers
  are reallocated from sector 1 to sector 2 and as
  a result, the wage rate in sector 2 falls.
• Because 6 is less than the competitive wage of
  9, workers are not allocated to their most
  productive jobs.
• The wage floor yields an equilibrium with
  underemployment.

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From Figure 12.4

• Assume there are unionized and non-unionized
  sectors and that the unionized sector is
  characterized by a shape up (all members turn
  up each day and a union official picks the
  members who work that day).
• Workers are free to seek work in either sector.
  The number of workers looking for jobs in the
  union shape up is z1 and those looking in the
  non-unionized sector is z2.

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From Figure 12.4

• 20 jobs at the union wage of 12 are shared by
  all union members.
• Assuming the jobs are shared equally, the
  proportion of time that any union member will be
  employed is 20/z1 (jobs/union members).
• The expected wage is the union wage (12) times
  20/z1 or 240/z1.

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Figure 12.5 Wage floors and search unemployment
in a two-sector model
19
From Figure 12.5

• Figure 12.5 is different from 12.4 in that the
  expected wage rate is plotted in quadrant I.
• Notice that the expected wage relationship passes
  point G in quadrant I because when 20 union
  workers look for jobs in the shape up each is
  employed full time at the union wage of 12 per
  hour.

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From Figure 12.5

• Suppose the workers continue to join the union
  sector until the expected wage in the union
  sector equals that on the non-union sector.
• Equilibrium allocation is at point C in quadrant
  III, with a wage of 8.

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From Figure 12.5

• At equilibrium point C
• 30 unionized workers are chasing 20 union jobs
  paying 12.
• As unionized workers split available work
  equally, the expected wage is 240/30 8.

22
From Figure 12.5

• At equilibrium point C
• 70 workers are employed in sector 2
• Unemployment equals u in quadrant I, (10 full
  time workers).
• Note that in equilibrium in Figure 12.4 (point B
  in Figure 12.5), 80 non-union workers are
  employed in sector 2.

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From Figure 12.5

• It is necessary that the equilibrium wage in
  sector two of the underemployment model is lower
  than that in the unemployment model. Why?
• Because in the unemployment model, some non-union
  workers leave sector 2 to chase jobs in sector 1.
• As a result, the smaller number of non-union
  workers remaining in sector 2 will earn a higher
  wage.

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From Figure 12.5

• Two sources of inefficiency arise in this model
• There is unemployment equal to u in quadrant I.
• The allocation of workers who are employed is
  inefficient because the wage floor exceeds the
  equilibrium wage.

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Income Maintenance

• What institution is best for transferring income
  to the poorer members of society?
• Efficient transfer mechanism
• Topping-up mechanism
• Negative income tax

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Figure 12.6 An efficient income-transfer mechanism
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The Efficient Transfer Mechanism

• Although the lump-sum mechanism is efficient, it
  is not practical.
• There is no systematic way of choosing a target
  indifference curve or identifying individual
  preferences and budgets to pinpoint recipients.
• As a result, policies are formulated in terms of
  income-maintenance mechanisms rather than
  utility-maintenance mechanisms.

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Income-Maintenance Programs

• Income-maintenance programs have the objective of
  raising the income of anyone below a targeted
  level of income, up to that level.
• In practical income-maintenance schemes, the
  amount of the income transfer is conditional upon
  the amount of the recipients earned income.

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Topping Up and Welfare

• The essential feature of many welfare programs is
  a topping-up mechanism, where the subsidy is just
  large enough to put the recipient at the mandated
  income level.
• The result is that potential recipients can
  affect the amount of income transferred to them
  by choosing how much income they earn.

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Topping Up and Welfare

• If the potential recipient earns as much or more
  than the targeted income level (S), he/she will
  not get any subsidy.
• If he/she earns an income below S, the amount of
  the subsidy will be just enough to raise total
  income to S.
• This topping-up mechanism translates into the
  kinked budget line in Figure 12.7.

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Topping Up and Welfare

• This topping-up mechanism translates into the
  kinked budget line in Figure 12.7, which leads to
  inefficiency.
• The inefficiency occurs because the recipients
  MRS at E, is less than the wage rate.

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Figure 12.7 An inefficient income-transfer
mechanism
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The Negative Income Tax

• The negative income tax (NIT) combines the
  elements of the efficient lump-sum transfer and
  the topping-up mechanism.
• Though not problem-free, this combined scheme
  redistributes income to poorer members of society
  without the gross inefficiency and the perverse
  lack of work incentives associated with the
  welfare system.

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Figure 12.8 A negative income tax
35
From Figure 12.8

• This version of the NIT combines an unconditional
  income transfer for everyone (S) and a
  proportionate (yet moderate) income tax (t) on
  earned income.
• Everyone receives the subsidy (S), pays twh in
  taxes, keeps (1-t)wh from his/her earned income,
  and receives net income equal to
• x2 S (1-t)wh

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From Figure 12.8

• At point E in Figure 12.8, the budget line is
  tangent to the indifference curve and the person
  is indifferent between the NIT and the topping-up
  mechanism.
• This person works h hours and earns income equal
  to wh.

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From Figure 12.8

• Point E is not an efficient equilibrium because
  the MRS is less than w.
• The NIT offsets some of the inefficiencies
  associated with the topping-up mechanism and
  avoids the disincentive to work.
• It also makes smaller demand on the public purse
  (DE for the NIT versus S for the topping-up
  mechanism).

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The Market for Superstars

• Figure 12.9 shows two separate labour markets.
  There is a market demand and supply curve for
  talent levels of t0.25 and the same for talent
  levels of t0.35.
• Consumers are willing to pay more for talented
  singers and we assume they can produce more CDs.

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Figure 12.9 Labour markets with different levels
of talent
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The market for Superstars

• A superstar market is characterized by a good or
  service that has a poor substitutability between
  quantity and quality.
• Also a small number of individuals are able to
  supply the entire market.
• More talented labour produces more CDs and gets a
  higher wage.