Chapter 4: Labor Market Equilibrium PDF
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This document discusses labor market equilibrium, examining concepts like monopsony, monopoly, competitive equilibrium, and efficiency within labor markets. It also explores the impact of international trade (NAFTA) and migration on wages. The document is likely part of a larger economics textbook, focused on macroeconomics.
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Chapter 4 Labor Market Equilibrium © McGraw Hill, LLC 1 Introduction Labor market equilibrium coordinates the desires of firms and workers, determining the wage and employment observed in the labor market. Market types: Mono...
Chapter 4 Labor Market Equilibrium © McGraw Hill, LLC 1 Introduction Labor market equilibrium coordinates the desires of firms and workers, determining the wage and employment observed in the labor market. Market types: Monopsony: one buyer of labor Monopoly: one seller of labor These market structures generate unique labor market equilibria. © McGraw Hill, LLC 2 Equilibrium in a Single Competitive Labor Market Competitive equilibrium occurs when supply equals demand, generating a competitive wage and employment level. It is unlikely that the labor market is ever in an equilibrium, since supply and demand are dynamic. The model suggests that the market is always moving toward equilibrium. © McGraw Hill, LLC 3 Efficiency Pareto efficiency exists when all possible gains from trade have been exhausted. When the state of the world is (Pareto) Efficient, to improve one person’s welfare necessarily requires decreasing another person’s welfare. In policy applications, ask whether a change can make any one better off without harming anyone else. If the answer is yes, then the proposed change is said to be “Pareto-improving.” © McGraw Hill, LLC 4 Equilibrium in a Competitive Labor Market The labor market is in equilibrium when supply equals demand; E* workers are employed at a wage of w*. In equilibrium, all persons who are looking for work at the going wage can find a job. The triangle P gives the producer surplus; the triangle Q gives the worker surplus. A competitive market maximizes the value of output, or the sum P + Q. Access the text alternative for these images © McGraw Hill, LLC 5 Competitive Equilibrium Across Labor Markets If workers were mobile and entry and exit of workers to the labor market was free, then there would be a single wage paid to all workers. The allocation of workers to firms equating the wage to the value of marginal product is also the allocation that maximizes national income (this is known as allocative efficiency). The “invisible hand” process: self-interested workers and firms accomplish a social goal that no one had in mind, that is, allocative efficiency. © McGraw Hill, LLC 6 Efficiency Revisited The “single wage” property of a competitive equilibrium has important implications for economic efficiency. Recall that in a competitive equilibrium the wage equals the value of marginal product of labor. As firms and workers move to the region that provides the best opportunities, they eliminate regional wage differentials. Therefore, workers of given skills have the same value of marginal product of labor in all markets. The allocation of workers to firms that equates the value of marginal product across markets is also the sorting that leads to an efficient allocation of labor resources. © McGraw Hill, LLC 7 Wages and International Trade: NAFTA NAFTA created a free trade zone in North America. Free trade reduces the income differential between the United States and other countries in the zone, such as Mexico. Total income of the countries in the trade zone is maximized as a result of equalized economic opportunities across the countries in the zone. © McGraw Hill, LLC 8 Competitive Equilibrium in Two Labor Markets Linked by Migration Suppose the wage in the northern region (wN ) exceeds the wage in the southern region (w S ). Southern workers want to move North, shifting the southern supply curve to the left and the northern supply curve to the right. In the end, wages are equated across regions at w*. Access the text alternative for these images © McGraw Hill, LLC 9 Wage Convergence Across States Source: Blanchard, O. J., & Katz, L. F. (1992). Regional evolutions. Brookings Papers on Economic Activity, 1, 1 to 61. Access the text alternative for these images © McGraw Hill, LLC 10 Payroll Taxes and Subsidies Payroll taxes assessed on employers lead to a downward, parallel shift in the labor demand curve. The new demand curve shows a wedge between the amount the firm must pay to hire a worker and the amount that workers actually receive. Payroll taxes increase total costs of employment, so these taxes reduce employment in the economy. Firms and workers share the cost of payroll taxes, since the cost of hiring a worker rises and the wage received by workers declines. Payroll taxes result in deadweight losses. © McGraw Hill, LLC 11 The Impact on Payroll Tax Assessed on Firms A payroll tax of $1 assessed on employers shifts down the demand curve (from D0 to D1 ). The payroll tax decreases the wage that workers receive from w0 to w1 and increases the cost of hiring a worker from w0 to w1 1. Access the text alternative for these images © McGraw Hill, LLC 12 The Impact on Payroll Tax Assessed on Workers A payroll tax assessed on workers shifts the supply curve to the left (from S0 to S1 ). The payroll tax has the same impact on the equilibrium wage and employment regardless of who it is assessed on. Access the text alternative for these images © McGraw Hill, LLC 13 The Impact on Payroll Tax Put on Firms With Inelastic Supply A payroll tax assessed on the firm is shifted completely to workers when the labor supply curve is perfectly inelastic. The wage is initially w0. The $1 payroll tax shifts the demand curve to D1 , and the wage falls to w0 1. Access the text alternative for these images © McGraw Hill, LLC 14 Deadweight Loss of a Payroll Tax Access the text alternative for these images © McGraw Hill, LLC 15 Payroll Subsidies An employment subsidy lowers the cost of hiring for firms. This means payroll subsidies shift the demand curve for labor to the right (up). Total employment will increase as the cost of hiring has fallen. © McGraw Hill, LLC 16 The Impact of an Employment Subsidy An employment subsidy of $1 per worker hired shifts up the labor demand curve, increasing employment. The wage that workers receive rises from w0 to w1. The wage that firms actually pay falls from w0 to w1 1. Access the text alternative for these images © McGraw Hill, LLC 17 The Impact of a Mandated Benefit Access the text alternative for these images © McGraw Hill, LLC 18 Immigration As immigrants enter the labor market, the labor supply curve shifts to the right. Total employment increases. Equilibrium wage decreases. © McGraw Hill, LLC 19 Effect on Native-Born Workers Immigration reduces the wages and employment of similarly skilled native-born workers, but native-born workers may be able to increase their productivity by specializing in tasks better suited to their skills. Competing native workers will have lower wages; complementary native workers will have higher wages. © McGraw Hill, LLC 20 The Short-Run Impact of Immigration When Immigrants and Natives Are Perfect Substitutes As immigrants and natives are perfect substitutes, the two groups are competing in the same labor market. Immigration shifts out the labor supply curve. As a result, the wage falls from w0 to w1 , and total employment increases from N0 to E1. At the lower wage, the number of natives who work declines from N0 to N1. Access the text alternative for these images © McGraw Hill, LLC 21 The Short-Run Impact of Immigration When Immigrants and Natives Are Complements If immigrants and natives are complements, they do not compete in the same labor market. The labor market here denotes the supply and demand for native workers. Immigration makes natives more productive, shifting out the labor demand curve. This leads to a higher native wage and to an increase in native employment. Access the text alternative for these images © McGraw Hill, LLC 22 The Long-Run Impact of Immigration When Immigrants and Natives Are Perfect Substitutes Immigration initially shifts out the labor supply curve, so the wage falls from w0 to w1. Over time, capital expands as firms take advantage of the cheaper workforce, shifting out the labor demand curve and restoring the original wage and level of native employment. Access the text alternative for these images © McGraw Hill, LLC 23 Scatter Diagram Relating Wages and Immigration for Native Skill Groups Source: George J. Borjas, “The Labor Demand Curve Is Downward Sloping: Reexamining the Impact of Immigration in the Labor Market,” Quarterly Journal of Economics 118 (November 2003): 1335 to 1374. Access the text alternative for these images © McGraw Hill, LLC 24 The Short-Run Labor Demand Curve Implied by Different Natural Experiments (a) The analysis of data resulting from the Mariel natural experiment implies that increased immigration does not affect the wage, so that the short-run labor demand curve is perfectly elastic. (b) The analysis of data resulting from the NJ-Pennsylvania minimum wage natural experiment implies that an increase in the minimum wage does not affect employment, so that the short-run labor demand curve is perfectly inelastic. Access the text alternative for these images © McGraw Hill, LLC 25 Policy Application: High-Skill Immigration There is a widespread perception that some types of immigration, particularly the immigration of high-skill workers, can be hugely beneficial. High-skill immigrants generate human capital externalities. The sudden presence of high-skill immigrants exposes natives to new forms of knowledge, increases their human capital, and makes them more productive. If high-skill immigrants had positive spillover effects on native productivity, an influx of immigrants induces an outward shift in the labor demand curve because the value of marginal product for a native worker rises. © McGraw Hill, LLC 26 FIGURE 4-16 The Immigration Surplus in the Presence of Positive Externalities Access the text alternative for these images © McGraw Hill, LLC 27 Policy Application: COVID-19 and the U.S. Labor Market Some of the early evidence on how the labor demand shocks induced by the COVID-19 pandemic (and the subsequent governmental responses) led to sudden and historic shifts in labor market conditions in the United States. Given the scale of the historic changes in labor market conditions and the possibility that new variants of the coronavirus might continue to disrupt the economic recovery, it is extremely difficult (as of early 2022) to predict how wages and employment will continue to evolve in the most affected sectors, as well as increase inequality in job opportunities. © McGraw Hill, LLC 28 FIGURE 4-19 The Employment–Population Ratio During the COVID-19 Pandemic Source: Current Population Surveys, Basic Monthly Files. The employment-population ratio is calculated in the sample of persons aged 18 to 64 who are not in the military. Access the text alternative for these images © McGraw Hill, LLC 29 FIGURE 4-20 The Employment Impact of the COVID-19 Pandemic Across Industries Source: Current Population Surveys, Basic Monthly Files. The vertical axis gives the number of workers aged 18 to 64 in each sector, normalized to equal 1 in January 2020. Access the text alternative for these images © McGraw Hill, LLC 30 Noncompetitive Labor Markets: Monopsony Monopsony market exists when a firm is the only buyer of labor. Monopsonists must increase wages to attract more workers. Two types of monopsonist firms: Perfectly discriminating Nondiscriminating © McGraw Hill, LLC 31 Perfectly Discriminating Monopsonist Discriminating monopsonists are able to hire different workers at different wages. To maximize firm surplus (profits), a perfectly discriminating monopsonist “perfectly discriminates” by paying each worker their reservation wage. © McGraw Hill, LLC 32 Nondiscriminating Monopsonist Must pay all workers the same wage, regardless of each worker’s reservation wage. Must raise the wage of all workers when attempting to attract more workers. Employs fewer workers than would be employed if the market were competitive. © McGraw Hill, LLC 33 The Hiring Decision of a Perfectly Discriminating Monopsonist A perfectly discriminating monopsonist faces an upward- sloping labor supply curve and can hire different workers at different wages. Therefore, the labor supply curve gives the marginal cost of hiring. Profit maximization occurs at Point A. The monopsonist hires the same number of workers as a competitive market, but each worker is paid their reservation wage. Access the text alternative for these images © McGraw Hill, LLC 34 The Hiring Decision of a Nondiscriminating Monopsonist A nondiscriminating monopsonist pays the same wage to all workers. The marginal cost of hiring exceeds the wage, and the marginal cost curve lies above the supply curve. Profit maximization occurs at Point A; the monopsonist hires EM workers and pays them all a wage of wM. Access the text alternative for these images © McGraw Hill, LLC 35 The Impact of the Minimum Wage on a Nondiscriminating Monopsonist The minimum wage may increase both wages and employment when imposed on a nondiscriminating monopsonist. A minimum wage set at w increases employment to E. Access the text alternative for these images © McGraw Hill, LLC 36