Chapter 12: The Factor Markets: The Labour Market PDF

© VAN SCHAIK PUBLISHERS Chapter 12: The factor markets: the labour market  Learning outcomes Once you have studied this chapter you should be able to: Identify the main differences between the labour market and the goods market Explain the main determin...

© VAN SCHAIK PUBLISHERS Chapter 12: The factor markets: the labour market  Learning outcomes Once you have studied this chapter you should be able to: Identify the main differences between the labour market and the goods market Explain the main determinants of the supply of labour Explain how the demand for labour is derived Explain how a perfectly competitive labour market functions Analyse various labour market imperfections Discuss the desirability of minimum wages Explain why wages differ © VAN SCHAIK PUBLISHERS  Introduction The factor market is a market for factors of production. More specifically we look at the labour market (and briefly at the other factor markets). The labour market is of national importance as seen from issues of employment/unemployment. Employment creation is thus a macroeconomic objective for most if not all countries. Key points: 1. Perfectly competitive labour market 2. Supply of and demand for labour 3. Determinants of wages 4. Imperfectly competitive labour markets and the need for trade unions and/or government intervention © VAN SCHAIK PUBLISHERS  The labour market versus the goods market Labour market links buyers and sellers. In the labour market individuals supply their skills or labour services and not consumer goods and services The worker has to be present after being hired for his services to be used. As a result, location of employment and working conditions are important considerations in this market. Skills embodied in the person are not transferable unlike goods that can easily be transferred from seller to buyer. Labour is always rented and not sold (you cannot buy a person). Because this market deals with human being we have trade unions, collective bargaining, government intervention etc. Hiring of labour is usually on contract terms making this market different from the goods/services market. Goods can be standardized or made homogeneous, but labour is difficult and usually heterogeneous. The remuneration comes not as wage only but also non-wage benefits e.g transport allowance, medical aid etc. © VAN SCHAIK PUBLISHERS Requirements for perfect competition Large number of buyers and sellers. Wage takers(no one influence wage). Homogeneous/identical labour/skills-no reason for employer to prefer one worker to another. Complete/perfect mobility: free entry and exit from one employer to another. No government intervention. Perfect knowledge of market conditions e.g. jobs available, wage rates.  A perfectly competitive labour market Requirements for perfect competition Equilibrium in the labour market Figure 12-2 Equilibrium in a perfectly competitive labour market (Textbook page 210) © VAN SCHAIK PUBLISHERS The individual supply of labour Quantity of labour supplied by firms will rise as wage rate increases but for individuals, only to a certain point(maximum point). At maximum, the worker feels that he is able to maintain a reasonable standard of living and can afford to have rest or leisure time as wage rate continues to increase. The supply curve will then start to bend (quantity of hours offered decline ) resulting in a backward bending supply curve as a result of substitution and income effects. Substitution effect: as wage rate increases the opportunity cost of leisure also increases and so workers will substitute leisure with work to earn more ands hence ss curve increases. Income effect: as the wage rate keeps rising, consumers are able to consume more hence their marginal utility declines till it reaches zero. Also leisure being a normal good whose demand increase as income increases, will rise and workers will prefer to enjoy leisure more.  A perfectly competitive labour market The individual supply of labour Figure 12-3 The individual supply of labour (Textbook page 211) © VAN SCHAIK PUBLISHERS Market supply of labour In general, more workers will join the market when wage rate is increasing. This increases the quantity of labour supplied ceteris paribus. The market supply curve will have a positive slop just like a normal supply curve It is the individual supply curve that is backward bending and not the whole market’s supply curve NOTE: the firms supply curve will be horizontal (perfectly elastic) at the price determined by the market forces remember this is perfect competition  A perfectly competitive labour market The market supply of labour Figure 12-4 The market supply of labour (Textbook page 212) © VAN SCHAIK PUBLISHERS  A perfectly competitive labour market An individual firm’s demand for labour The wage rate is determined by the market forces. The firm can employ any quantity of labour at the rate determined. Supply of labour will then be a horizontal line at this wage rate which is equals to the MCL to the firm Box 12-2 Imperfect competition in the product market and the demand for labour (Textbook page 214) Figure 12-5 A perfectly competitive labour market (Textbook page 213) © VAN SCHAIK PUBLISHERS  The MCL(marginal cost of labour) is given, the firm has to look at MBL(marginal benefit of labour) to determine what units of labour to employ. MBL has two components: physical productivity of labour and marginal revenue from selling an additional unit of its product. Marginal Physical Product (MPP) which is the additional product gained from employing an additional worker is important in making decisions. The Marginal Revenue (MR). The increase (marginal) in total revenue in monetary terms (MRP) to the firm is therefore calculated by multiplying MPP by MR. MRP=MPP X MR ,in the perfect competition MR=P so MRP=MR X P Equilibrium(maximum profit): MRP=W. if MRP>W then additional worker contribution to firms revenue is greater than the cost of hiring him the firm should hire more till equilibrium is reached. MRP is therefore the firms demand curve.  A perfectly competitive labour market An individual firm’s demand for labour Table 12-1 Calculation of the marginal revenue product of labour: an example (Textbook page 214) © VAN SCHAIK PUBLISHERS  A perfectly competitive labour market An individual firm’s demand for labour Figure 12-6 The individual firm’s demand for labour (Textbook page 215) © VAN SCHAIK PUBLISHERS  A perfectly competitive labour market An individual firm’s demand for labour Figure 12-7 The equilibrium position of a firm operating in a perfectly competitive labour market (Textbook page 215) © VAN SCHAIK PUBLISHERS  Shifts and movements in the demand curve Market demand for labour has a negative (downward) slope. Changes in labour market equilibrium: 1. Change in wage rate will result in movement along the demand curve. 2. Change in non-wage factors will result in Shift of the demand curve: Market demand curve will shift if: Number of firms change Price of the goods produced change -productivity changes Price of substitute factors of production changes Price of complementary factors change  A perfectly competitive labour market The market demand for labour Changes in labour market equilibrium Figure 12-8 Changes in labour market equilibrium (Textbook page 217) © VAN SCHAIK PUBLISHERS  A perfectly competitive labour market Changes in labour market equilibrium Figure 12-8 Changes in labour market equilibrium continued © VAN SCHAIK PUBLISHERS Shifts in supply curve The market supply curve will shift as a result in changes in non-wage determinants: 1. New workers enter the market (population increase) 2. Number of workers decrease (e.g. due to death) 3. Shift of labour force to other attractive occupations or markets 4. Change in non-monetary aspects of the job e.g. benefits on that job not attractive An increase in supply will shift SS curve to the right changing the equilibrium in the market A decrease in the SS will shift the SS curve to the left changing the equilibrium in the market  A perfectly competitive labour market Changes in labour market equilibrium Figure 12-8 Changes in labour market equilibrium continued © VAN SCHAIK PUBLISHERS  A perfectly competitive labour market Changes in labour market equilibrium Figure 12-8 Changes in labour market equilibrium continued © VAN SCHAIK PUBLISHERS  Imperfect labour markets Perfect competition is usually a benchmark, and the reality is more of imperfect markets and the labour market is characterized by imperfections that arise as a result of some of the following: 1. Workers are usually organized in trade unions that acts as monopolistic suppliers of labour. 2. Some markets are characterized by only one/one major employer who becomes a monopsony. 3. Labour is heterogenous, workers have different education, skills, traits, characters etc. 4. Mobility of labour is not always free or easy. Workers cannot easily change from one occupation/employer/region to another. 5. Government will always intervene in the labour market through labour laws, legislations etc. 6. Information and knowledge is not readily available or accessible eg. People have to look for jobs/vacancies the information is not always readily available. 1. Trade unions Individual workers are usually at a disadvantage/powerless when it comes to negotiating with employers. At times workers become too desperate and accept whatever the employer say because they have little or no bargaining power. Workers therefore often join trade unions to represent them. Trade unions will negotiate wages, working conditions, fringe benefits etc. Mainly they have an effect on the wage rate and as a result on the level of employment in the economy. There are two categories of trade unions: 1. Craft unions: Brings together workers with the same skill e.g. electricians, and join them together irrespective of where they work. Craft unions control the supply of skilled labour in that profession e.g. by controlling the length of training/experience needed/ apprenticeship. 2. Industrial unions: Brings together all workers working in the same industry (skilled or not). Industrial Union aim at getting complete control over labour supply in the industry. They do this by increasing the wage rate and not restricting supply as the craft union.  Imperfect labour markets Figure 12-9 Ways in which a trade union can attempt to increase the wage rate (Textbook page 219) When they restrict/reduce supply successfully the supply curve shifts to the left increasing the wage rate and reducing the level of employment as shown on the graph. © VAN SCHAIK PUBLISHERS  Imperfect labour markets Trade unions Figure 12-9 Ways in which a trade union can attempt to increase the wage rate continued They enforce or negotiate for a higher wage above the equilibrium. This will result in the industry operating at disequilibrium wage rate and firms will be forced to reduce employment. This can only be sustained if the union can prevent non-union members from accepting a lower rate. © VAN SCHAIK PUBLISHERS  Imperfect labour markets Trade unions Figure 12-9 Ways in which a trade union can attempt to increase the wage rate continued Unions can also try to influence demand for labour so as to increase the wage and or employment levels. This will result in a win-win situation for both workers and employees. The demand curve will shift to the right wages as well as employment level will increase. © VAN SCHAIK PUBLISHERS 2. Monopsony Single buyer or employer. Or it can be that employers can organize themselves into union that represents them and therefore acts a single employer Equilibrium for the monopsony occurs when the MCL>ACL , and not equal as in perfect competition 3. Bilateral monopoly If we have a single trade union representing workers and a single employers organization representing employers, then we have a bilateral monopoly i.e. monopolist (trade union) and monopsonist (employer organisation). When bilateral monopoly negotiates the outcomes are uncertain and will depend on the negotiating powers or skills of each side.  The relative bargaining strength 1. The ratio of wage cost to total cost. 2. Changes in productivity. 3. The relationship between the wages paid in the industry and the wages paid elsewhere for similar work. 4. The nature of the product. 5. The price elasticity of the demand for the product. 6. The degree to which the union controls the supply of labour. 7. The level of unemployment. 8. The extent to which machinery can readily replace labour. 9. Increases in the cost of living. 10. The structure of the goods market.  Imperfect labour markets Monopsony Table 12-2 The cost and marginal revenue product of labour in a monopsonistic labour market (Textbook page 220) © VAN SCHAIK PUBLISHERS  Imperfect labour markets Bilateral monopoly Figure 12-10 Wage and employment determination in a monopsonistic labour market (Textbook page 221) A monopsony will employ labour up to a point where MCL=MBL/MRP @ 4 units, but will pay a wage a price equal to ACL © VAN SCHAIK PUBLISHERS  Imperfect labour markets Government intervention in the labour market Government often intervene in the markets to set minimum wages and it considers basic needs, minimum living wage etc. to put the workers in a better position. Advantages of minimum wage 1. Helps disadvantaged workers who cannot negotiate for better wages. 2. Avoids exploitation of workers by employers especially if jobs are scarce. 3. May increase productivity as it motivates workers to work more. 4. Help increase demand for goods since wages are the main sources of income. Disadvantages of minimum wage 1. Wages are a significant part of cost of production and so minimum wages may increase the costs of production. 2. The increase in costs may be passed to consumers as high prices. 3. Firms may reduce the number of employees, and this will increase unemployment rate. © VAN SCHAIK PUBLISHERS  Imperfect labour markets Minimum wages – A Minimum wage in a perfectly competitive labour market Figure 12-11 The impact of the imposition of a minimum wage in a perfectly competitive labour market (Textbook page 224) If minimum wage is set above equilibrium excess supply of labour will develop. Quantity demanded will fall and supply will increase. This will result in unemployment. © VAN SCHAIK PUBLISHERS  Imperfect labour markets Minimum wages – A Minimum wage in a monopsonistic labour market Figure 12-12 The impact of the imposition of a minimum wage in a monopsonistic labour market (Textbook page 224) Mininimum wage is set at Wm and the supply curve becomes Wmab and MCL will be Wmacd. Nm becomes the new employment level which is more than the equilibrium employment. So long as the wage rate is set below W1 it will increase the employment level for monopsonistic. Concluding remarks on minimum wages The level at which the minimum wage is placed is crucial. Setting it below equilibrium will have no impact at all, setting it above equilibrium the effect will depend on market structure. © VAN SCHAIK PUBLISHERS  Imperfect labour markets Labour immobility and imperfect information In perfect competition labour is assumed to be mobile and information is assumed to be available. In reality this is not the case. Geographical immobility § Inability unwillingness to relocate due to social/family ties, cost of moving etc. Occupational immobility § Lack of qualification/ability to do alternative/available job. § Lack of information on opportunities available you will have to pay a cost (search costs) to be able to know available jobs. © VAN SCHAIK PUBLISHERS  Wage differentials Job-related differences-jobs differ some are dangerous, dirty, risky etc that people prefer not to do them. Higher wages will be paid to attract people to compensate. Worker-related differences-people differ and are not homogeneous in terms of how they work, experience and natural talents. So wages will differ according to your talent and skills. Differences related to market structure-relative market power of employees and employers differ from market to market and can result in different wages Differences as a result of discrimination- for example women may be restricted to female jobs or paid less for doing the same jobs as man. Racial discrimination can also occur and cause wage differences Differences in productivity- if a worker is more productive he gives greater value/contribution to the employers activities and a higher wage will usually be paid. E.g pay based on commission © VAN SCHAIK PUBLISHERS  Other factor markets Land (natural resources) and rent Land is a natural resource and is often fixed in total supply. Demand of land is the one that changes and affect the price for land - Rent Capital and interest Plants, machinery etc. Payment for capital is interest. Interest is determined by the interaction of demand (for borrowed funds to invest in capital goods) and supply ( savings of people) for loanable funds. Entrepreneurship and profit An entrepreneur is a person who takes the initiative to combine the other factors of production in producing goods and services he is rewarded by profit.  Appendix 12-1: Other factor markets Land (natural resources) and rent © VAN SCHAIK PUBLISHERS  Appendix 12-1: Other factor markets Capital and interest Entrepreneurship and profit © VAN SCHAIK PUBLISHERS  Important concepts Wage rate Monopsony Earnings Collective bargaining Nominal wage Bilateral monopoly Real wage Flexible labour market Supply of labour Minimum wages Backward-bending supply Mobility of labour curve Wage differentials Demand for labour Compensating wage Derived demand differential Marginal physical product Investment in human capital Marginal revenue product Discrimination Marginal cost of labour Productivity Trade union © VAN SCHAIK PUBLISHERS