Lecture 5 Labor Market Equilibrium

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Lecture 5 Labor Market Equilibrium

• Workers prefer to work when the wage is high, and
  firms prefer to hire when the wage is low. Labor
  market equilibrium balance out the conflicting
  desires of workers and firms and determines the
  wage and employment observed in the labor market.

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1. Equilibrium in a Single Competitive Labor
Market
Dollars

• The supply curve gives the total number of
  employee-hours that agents in the economy
  allocate to the market at any given wage level
  the demand curve gives the total number of
  employee-hours that firms in the market demand at
  that wage. Equilibrium occurs when supply equals
  demand, generating the competitive wage w and
  employment E .

S
W
D
E
Employment
Equilibrium in a Competitive Labor Market
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 Markets
The economy typically consists of many labor
markets, even for workers who have similar
skills. As long as either workers or firms are
free to enter and exit labor markets, a
competitive economy will be characterized by a
single wage.
SN
Dollars
Dollars
SN
SS
SS
WN
W
W
WS
DS
DN
Employment
Employment
Competitive Equilibrium in Two Labor Markets
Linked by Migration
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• Note The single wage property of competitive
  equilibrium has important implications for
  economic performance. That is, workers of given
  skills have the same value of marginal product of
  labor in all markets. The allocation of workers
  to firms which equates the value of marginal
  product across markets is also the allocation
  which maximizes national income. This type of
  allocation is called an efficient allocation.

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3. Policy Application Payroll Taxes

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

Tax is a fixed dollar amount X. D0?D1 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.
Tax
Real Wage
S0
W0?
W1X
W0
W1
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 employees wages.
D0
D1
E1
E2
E0
Employment
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4. The Cobweb Model

• Our analysis of labor market equilibrium assumes
  that markets adjust instantaneously to shifts in
  either supply or demand curves, so that wages and
  employment change swiftly from the old
  equilibrium levels to the new equilibrium level.
  Many labor markets, however, do not adjust so
  quickly to shifts in the underlying supply and
  demand curves.
• Example the Engineering Market
• Note The adjustment of college enrollments
  to changes in the returns to education is not
  always smooth or rapid, particularly in fields
  that are highly technical.
• ? The inability to respond immediately to changed
  market conditions can cause boom-and-bust cycles
  in the market for highly technical workers.

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Wage
S
W1
W3
We
W2
D
W0
D
N2
N3
N1
N0
Number of Engineers
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
  eventually
• equilibrium is reached. ? cobweb model.
• Note There are two key assumptions in the cobweb
  model
• It takes time to produce new engineers, so that
  the supply of engineers can be thought of as
  being perfectly inelastic in the short run.
• Students are very myopic when they are
  considering whether to become engineers.

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5. Policy Application The Impact of Minimum Wages

• The standard economic model of the impact of
  minimum wages on employment is illustrated in the
  following figure

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.
Dollars
S
W
W
D
E
ES
E
Employment
The Impact of the Minimum Wage on Employment
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The Covered and Uncovered Sectors
SU
Dollars
Dollars
SC
SU
W
SU
W
W
DC
DU
EC
EU
EU
EU
Employment
E
Employment
(a) Covered Sector
(b) UNcovered Sector
The Impact of Minimum Wages on the Covered and
Uncovered Sectors
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• Note In the absence of a minimum wage, the
  migration of workers across sectors equates the
  wage in the two sectors. The migration of
  workers when the wage in one of the markets is
  set at the minimum wage equates the expected wage
  across sectors. I.e., the free migration of
  workers across sectors ensure that the expected
  wage in the covered sector equals the for-sure
  wage in the uncovered sector.

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6. Noncompetitive Labor Markets

• Monopsony
• Because the firm is the only demander of
  labor in this market, it can influence the wage
  rate. Monopsnoists face an upward-sloping supply
  curve. This is because the supply curve
  confronting them is the market supply curve.
• Note To expand its work force, a monopsonist
  must increase its wage rate, i.e., the marginal
  cost of 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.
MRP MCL
MCL
W
Wages are below marginal revenue product for a
monopsonist.
S
WC
Wm lt WC and Em lt EC
Wm
MRP
L
Em
Ec
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• (2) Monopoly
• A monopoly trying to maximize profits and
  facing a competitive labor market will hire
  workers until its marginal revenue product equals
  the wage rate
• MRP (MPL)(MR) W
• ? (MR/P)(MPL) (W/P)
• lt1
• The demand-for-labor curve for a firm that
  has monopoly power in the output market will lie
  below and to the left of the demand-for-labor
  curve for an otherwise identical firm that takes
  product prices as 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.
Dollars
A
W
VMPE
MRPE
Em
E
Employment
The Labor Demand of a Monopolist