Labor Market Theory

• Labor market - the market for employers (consumers) and job seekers (producers)

Supply and Demand §

• Price now refers to salaries and wages.

• Quantity refers to the quantity of labor that is demanded.

• Shifts in labor demand can occur for a variety of reasons

  • More demand for the good produced = more demand for labor to match production needs
  • More education = more demand from a productive labor pool.
  • Technologies that act as substitutes = less demand for labor
  • Technologies that act as complements = more demand for labor.
  • Better technology = increased demand for skilled workers who can use the technology
  • More companies producing a product = more demand for employees who can produce that product.
  • Government regulation can increase or decrease demand for labor.
  • Higher prices and costs for additional production inputs = lower demand for labor to balance costs and revenues.
  • Lower prices and costs for additional production inputs = higher demand for labor to increase productivity.

• Shifts and labor supply can be affected by various factors.

  • More workers = more supply .
  • Higher standards required by employers = lower supply
  • Government policies can increase or decrease labor supply.

• Imperfect labor markets arise due to either the employers or the employees

Labor Market Competition §

• The First Rule of Labor Markets - If a firm want to maximize profits, it will never pay more (in terms of wages and benefits) for a worker than the value of their marginal productivity to the firm .
• The demand for labor is defined as the marginal product of labor (in products per hour) times the value of that output to the firms

  • The demand for labor is dependent on the marginal revenue. In particular the quantity of labor demanded is given by

  • In a perfectly competitive labor market, firms can hire all the labor they want up to when market wage equals the demand for labor.

  • If the market is imperfectly competitive, employment will be lower because the demand for labor is lower.

Monopsony §

• Laborers have the disadvantage in the labor market since they have need employment more than the employer needs them.
• A monopsony is an employer exploiting its market power wherein it has no competition in hiring so it can offer lower wages.
  • However, monopsonies are subject to the supply curve of labor. They must raise the wage they pay not just for new workers but for all existing workers at the previous lower wage. The marginal cost of hiring additional labor is greater than the wage and it is above the market supply of labor.
  • A monopsony will hire up until the demand for labor equals the marginal cost of additional labor.
  • Despite the incentive to lower wages, a monopsony will behave qualitatively similar to that of a perfectly competitive labor market due to market pressures (though monopsonies will hire less workers and pay lower wages).

Labor Unions §

• Labor unions function like monopolies in a labor market because they require employers to deal with workers collectively and it acts as a single source of labor.

  • Unions, assuming a market where they are the only source of laborers, can threaten that firms should pay higher wages, above what the equilibrium wage would be otherwise, and more workers than what a firm would have been willing to hire at that price.
    • Some unions have opposed firms using physical capital to get around unionized labor since this also reduces labor.
    • Other unions have also advocated for labor-saving technologies, typically for reasons of safety but also productivity since better capital = more productivity.
  • From the perspective of the firm, unionized labor must offer higher productivity.
    • If there is higher productivity, firms can afford to pay for the unionized labor and demand shifts accordingly.
    • Otherwise, the firm incurs losses.
    • Firms may also end up using more physical capital and less labor.

• Proponents of labor unions contend that it protects worker rights

• Critics of labor unions contend that it only benefits the workers short term but in the long term, without labor firms will close and leave no employers .

• Some explanations for declining union membership ¹

  • Shift in demand for labor in markets that are not covered by the union.
  • Globalization and competition from foreign producers
  • Redundancy due to workplace protection laws
  • Legal and Cultural reasons that make it difficult for unions to organize workers and expand their membership.

Bilateral Monopoly §

• A situation where a monopsony meets a labor union.
• There will be less employment due to competing demands from both sides.
• The exact wage will depend on on which party has the bigger bargaining power.
  • If it’s the monopsonist, there will be lower wages
  • If it’s the labor union, there will be higher wages .

Labor Issues §

• Some common protections come in the form of labor laws
  • Minimum hourly wages. Minimum wage acts as a price floor.
  • Maximum hours of work before overtime rates
  • Child labor prohibitions
  • Occupational Health and Safety conditions in the workplace
  • Preventing discrimination
  • Providing family leave
  • Requiring advance notice of layoffs
  • Covering workers with unemployment insurance
  • Setting a limit on the number of immigrant workers form other countries

Discrimination §

• Discrimination can prevent laborers from making productive and meaningful contributions due to barriers of entry.

• It is often the case that minorities are explicitly paid less even when they have equal skill and expertise as other workers.

• However, note that not every inequity is due to overt discrimination from the employers. It could simply be that minorities do not have the skills and expertise needed as a result of inequitable education, segregation and other subtle forms of discrimination.

• Circumstance also plays a role — for example, mothers who have to leave to take care of their children.

• While competitive markets can allow some employers to practice discrimination, it can also provide profit-seeking firms with incentives not to discriminate Still, economic forces are not enough to completely eliminate discrimination.

• Public policy can make discrimination illegal. However these approaches may not approach systemic issues.

  • Affirmative action - efforts by government or businesses to give special rights to minorities in hiring and promotion to make up for past discrimination.

Immigration §

• In the ideal case, immigration is simply seen as an increase in population.

• In the typical case, immigrants are at a disadvantage since they do not have the credentials.

• Immigration can disrupt certain markets.

  • Due to lacking credentials, immigrants are commonly in unskilled labor, which threatens the domestic labor market for unskilled labor .
  • Immigrants can also contribute to the increased demand for local goods and services.
  • Immigrants impose costs due to state-run programs without paying as much in terms of taxes. Effectively, immigrants are an investment that taxpayers may not want.

• In the long term, immigration has more social benefits than social costs.

Poverty §

• Poverty arises from people falling below the poverty line — the income one needs for a basic standard of living.

• Certain demographics are less prone to poverty than others. Segregation plays a part in this.

• The poverty trap is a situation where incentivizing the impoverished to work also reduces the amount of government support they receive (i.e., they become ineligible which makes them unable to cover living expenses). Effectively a reverse form of success to the successful.

  • Policies against the poverty trap should consider that such a trap could reduce labor incentives.
  • Another issue is that it costs more to give more incremental rewards although the long-term benefits to incentivize labor outweigh this short term cost.

• Safety nets are programs that offer assistance to those below the poverty line and those slightly above it.

  • In order to prevent the poverty trap, these policies require the recipient to meet a quota in terms of minimum hours worked

Income Inequality §

• Income inequality compares the share of the total income in society that different groups receive.

  • Income is the flow of money received (typically per month or per annum)
  • Wealth is the sum of the value of assets a person has.

• Wealth distribution is more unequal than income distribution.

• A common measure for this is to rank each household by income and then divide them into quantiles (typically quintiles) to calculate the distribution of income.

• Another visualization is through a Lorenz curve which plots income quantiles vs cumulative share of income. Income inequality is measured by how far the curve deviates from the 45-degree line .

• Some causes of growing income inequality include the following:

  • Changing composition of households and family structures
  • A distribution shift in wages. Higher wages result from more demand for high-skilled labor and more supply of high-skilled workers (most commonly due to new technologies). Inequality emerges from when supply of lower skilled workers exceed demands

• A snapshot of inequality does completely model how people’s income rise and fall over time.

• Redistribution is a government policy to counteract income inequality whereby we take more from those with higher income and provide these to those with lower income. This comes with giving higher tax rates for the rich

• Ladders of Opportunity - compensates for privileges which may give children more employment opportunities than others of equal talent. These incentives allow children to attain an economic niche based on their interests and talents

• Incentives for economic equality or poverty reduction can injure incentives for economic output.

  • That said, while this danger exists, it is also possible to discover policies that do not injure incentives for economic output (i.e., a balance to the tradeoff)
  • The vote of the citizens act as a means to balance the tradeoff

Links §

• Shapiro, MacDonald and Greenlaw - Ch. 4, 14 - 15

• Scarcity, Supply, and Demand

Footnotes §

1. Applies specifically to US context in Shapiro, MacDonald and Greenlaw, but could be seen as general reasons as well. The most plausible reason is legality. ↩