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Labor Market Equilibrium
Chapter 5
Labor Market Equilibrium
Competitive Markets (firms and workers can freely
enter and exit )

Equilibrium outcome will be efficient 
Monopsonies

E*↓, w*↓ relative to competitive markets
Monopolies:
Applications:



Taxes
Subsidies
Immigration
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Equilibrium in a Single
Competitive Labor Market
Equilibrium:
Each firm hires up to the point
where
No unemployment



Anyone who wants to work at w* can
Individuals not working are looking
for w_w*
Firms not finding employees are
offering w_w*
Realistically, equilibrium will not
last because of shocks in modern
industrialized nations
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Competitive Equilibrium
Across Labor Markets
Labor markets may be differentiated by:
Region (north, south, etc)
 Industry (2 different production industries)

Assume:
Markets in two regions (north, south)
 Workers in the two regions have similar skills and
can substitute for one another
 Initially, ws < wn

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Competitive Equilibrium
Across Labor Markets, cont.
If workers have full mobility, southern workers will ___________
____________ where they can earn a higher wage

If firms have full mobility, northern firms will _______________
where they can pay a lower wage (not shown)

In the end,
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Competitive Equilibrium Across
Labor Markets  Efficiency
Efficiency:
Also maximizes national income
 If ws < wn, VMPs _ VMPn since profit-maximizing
firms hire up to the point where
 As workers migrate north, MPn_ and MPs_ until the
two are equated, and
 In the end, ___________________, and profits are
maximized

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Empirical Evidence
Do wages equate over time?

In the US, there is a strong ____________ correlation between
wages and annual growth of wages


Roughly 30% of the wage gap between states disappeared over a 30year period (states with lowest wages had highest growth rate)
Similar evidence in Japan, a less mobile country
Across countries: “Conditional convergence”


Does not apply to the wage gap between the rich and poor
countries because countries with lower human capital levels
do not grow as rapidly
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NAFTA: Mexico and the US
Mobility of firms should:
__crease demand for Mexican workers
 __crease demand for US workers with similar skills
 Eventually _______ wages across the two countries

Some workers will clearly benefit and some will
be harmed, but the total income of the two
countries should increase as North America
moves to a more __________ outcome
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Policy Application: Payroll Tax
Payroll tax

Employers pay a tax on total wage
bill
Employers who first paid w1 will
now be willing to pay only _____
to E1 workers

_____ward shift of labor demand
curve
New wage paid to workers:
Firms pay _____, because they
pay tax t to the government
______ workers hired (E2 _ E1)
Tax burden


Firms:
Employees:
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Policy Application: Employee Tax
Tax on workers

E1 workers first earned w1,
Workers now demand ______

______ward shift of labor supply
curve
New wage is ____
Workers earn _____, because
they pay tax t to government
_____ workers hired (E2 _ E1)
Tax burden


Firms:
Employees:
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Tax policy application: Summary
Note that the outcome is the same regardless of who is
taxed
Employee Tax:


w_, so ______ bears the cost by having to ________________
Full amount of tax not recovered for ________ (tax is greater
than the wage increase)
Payroll Tax:


w_, so _______bear the cost by ____________
Full amount of tax is not covered for ___________ by the
wage decrease (tax is greater than the wage decrease)
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Tax with no burden on the firm
Assume firm is taxed
Assume perfectly inelastic
supply
With tax, firm is only willing
to pay ______
Number of workers
________ _____________

Firm passes entire incidence of
the tax onto workers
Therefore, a more ________
supply curve passes more tax
burden onto employees

Recall that labor supply curve
for men is inelastic
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Empirical Example
Note: Evidence suggests firms pass approximately 90%
of tax burden onto employees
Suppose annual income = $30,000


Employee tax = 7.65%  $2295 annually
Employer tax = 7.65%  $2295 annually



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90% of tax shifted to worker: .9·2295 = $2066
Total employee tax = $2295 + 2066 = $4361 annually
If $4361 were invested annually at 3%, worker would
accumulate $263,675 by age 65
If worker lives to age 80, would need SS benefits of $21,000
annually

Average worker only receives $7,200
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Policy Application: Government
subsidy paid to employers
Subsidy lowers the cost of hiring
workers
Firms are willing to pay ______
(s recouped in the form of the
subsidy, so in essence, the firm is
only paying original wage, w1)
New wage paid to worker: __
Cost of employment for the firm:
_______
Benefits of subsidy


Firm:
Worker:
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Empirical Example
Assume:


Elasticity of demand = -0.5
Elasticity of supply = 0.3
A 10% subsidy (reduction in hiring costs) would:


Increase wage by 4%
Increase employment by 2%
Gains of a government subsidy may be limited


Firms may be unaware of programs
Firms may place a stigma on hiring targeted workers and do not
hire them even to benefit from employer subsidy programs
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Noncompetitive Labor
Markets: Monopsony
So far, competitive firms took p and w as given regardless of E*
Recall that perfectly competitive firms face a horizontal demand
curve given by the market price
Analogously, an individual firm faces a horizontal labor supply
curve, given w

It can hire as many workers as it long as it pays wage = w
Monopsony:

Must pay higher wages to attract more workers (p taken as given)
Note that all markets have upward-sloping supply curves, but
monopsonies are firms that face upward-sloping supply curves

Ex: one-company town
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Perfectly discriminating monopsonist
Monopsonist can hire different workers
at different wages


w15 for worker 15,
w20 for worker 20, etc.
Supply curve = ____

Wage paid for each worker is his ______
____________
Demand curve = ______

Price is taken as given
Firm hires up to the point where _____
____ (E*,w*), or where _____ = ______
Same __ as a competitive market, but __
is the wage for the last worker, and all
others were paid w _ w*
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Non-discriminating Monopsonist
Monopsonist pays all workers the same wage,
regardless of their reservation wages
Supply ≠ MC, but MC __creases as E increases
S _ MC

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

If the 9th worker costs $7, total labor bill = $63
If 10th worker demands $7.50, total labor bill = $75
MC of the 10th worker is $12, but wage was $7.50
Analogous to D > MR for a monopolist
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Non-discriminating Monopsonist, cont.
Firms hire up to the point
where ___ = ____
(EM,wM)
Monopsonist determines
wage from _______
curve, not MCE curve

Similar to how
monopolists choose P
from the demand curve,
not MR
EM _ EC and wM _ wC
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Monopsony and Minimum Wage
Set wmin > wM, and firm can hire E*
employees
MC = wmin up to E* employees, then
returns to MC curve above supply
curve
Firm wants to hire where ______ =
_____, which is E* employees (point
A) at min wage, wmin
Outcome: wmin _ wM and E* _ EMno unemployment
Better outcome: set wmin = __ so E
= __ and w = __
Minimum wage law outcomes may
be explained by fast food restaurants
acting as monopolists to teenagers
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Competitive firms facing upwardsloping supply curves
Even if employees are mobile, the costs
associated with moving to take advantage of a
new higher paying job can be huge

Competitive firms must offer large wages to attract
someone to move
As the number of employees increases,
monitoring workers to discourage shirking
becomes expensive

Employers may want to pay higher wages to make
the cost to an employee of shirking more expensive
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Professional Athletes
Free agency

If a player can go where he wants, he will present his current
team with an outside offer
Current team evaluates VMP, and if VMP exceeds offer,

If not,

No free agency

New team can offer current team a trade – pay salary +
bonus to total their value for the player
Current team evaluates VMP and agrees to trade if

If VMP exceeds offer,

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Professional Athletes, cont.
Allocation of resources (players)

Player may not be paid according to worth, but he ends
up with the team that values him the most (VMP) in
either case
Different income distribution

__________ benefits from no free agency, but ________
benefits as a free agent
Empirical evidence: supports migration and income
distribution predictions
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Noncompetitive Labor
Markets: Monopoly
Monopoly:
Recall: Monopsonist did not control
p, but could choose w
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Monopoly, cont.
When output increases,
monopolist must ______ price
on that unit and all previous
units

MR _ P, where P is represented
by ______ since the firm chooses
P* from demand curve after Q*
is chosen (MR=MC)
Competitive outcome: ______
PC _ PM and QC _ QM
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Monopoly, cont.
Since P≠MR, revenue generated
by last worker hired is not equal
to MPE·P = VMPE
Instead, marginal revenue
product = MRPE =

MPRE _ VMPE because MR < P
π-max: w = ___, not w = VMP
EM _ EC, where EC is found be
equating wage to value of
marginal product
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Empirical Evidence
Monopolists and oligopolists (few firms
produce all of the output for an entire
market) pay higher wages than competitive
firms (approximately 10% more)
Monopolists can pass high production costs
onto consumers, so with little incentive to
keep costs down, monopolists must pay high
wages for the most desirable workers
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