Download Lecture 2: Labor Supply : Theory and Evidence

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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.
1. Equilibrium in a Single Competitive Labor Market
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*.
Dollars
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.
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.
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Dollars
Dollars
SN
S’N
S’S
WN
W*
SS
W*
WS
DN
DS
Employment
Employment
Competitive Equilibrium in Two Labor Markets Linked by Migration
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.
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
Re1∣Wage
W0+λ
W1+X
S0
W0
W1
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
D0
employment levels.
D1
E2
E1
E0
Employment
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 employee’s wages.
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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.
Wage
S
W1
W3
We
W2
W0
D’
D
N0 N2
N3 N1
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:
(1) It takes time to produce new engineers, so that the supply of engineers
can be thoughts of as being perfectly inelastic in the short run.
(2) Students are very myopic when they are considering whether to become
engineers.
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:
Dollars
S
W
W*
D
E
E*
Es
Employment
The Impact of the Minimum Wage on Employment
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.
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The Covered and Uncovered Sectors
Dollars
Dollars
S’’U
SC
SU
S’U
W
W*
W*
DC
E
EC
Employment
DU
E’’U EU E’U
Employment
(a) Covered Sector
(b) UNcovered Sector
The Impact of Minimum Wages on the Covered and Uncovered Sectors
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.
6. Noncompetitive Labor Markets
(1) 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.
To maximize profits, we know that any firm should hire labor until
the points at which marginal revenue product equals marginal cost.
MRP = MCL
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W
MCL
S
Wages are below marginal
revenue product for a
monopsonist.
WC
Wm
MRP
Wm < Wc and Em < Ec
L
Em
EC
(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)
<1
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.
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
MRPE
EM
E*
VMPE
Employment
The Labor Demand of a Monopolist