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Chapter 8 The Labour Market - Wage Determination v2

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PowerPoint Presentation: 

Chapter 8 The Labour Market: Wage Determination

 

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Learning Objectives At the end of this chapter you will be able to Understand the model of wage determination and be able to assess the role of market forces in determining relative wage rates Understand how monopsony power, trade unions and imperfect information contribute to labour market imperfection Understand the various factors that affect the ability of trade unions to influence wages and levels of employment in different labour markets Understand the conditions necessary for wage and other types of discrimination

 

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Wage Determination Pay in a particular labour market is influenced by a number of factors Along with demand and supply these include influence of trade unions and professional organisations, government intervention and esteem Demand and Supply plays a key role The wage paid to a particular occupation will rise with a rise in demand for their services or a fall in supply of their services The wages of website designers has risen as increasing internet use has increased demand for their services An increase in demand for website designers results in a rightward shift of the demand curve and a subsequent increase in the wage rate from W1 to W2

 

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David Ricardo’s theory of economic rent The theory of economic rent says that there are two separate elements in the payment made to labour (transfer earnings and Economic rent) Example Rooney earns £200,000 per week The next best paid job he is willing and able to do is an estate agent that pays £800 per week Economic rent is £200,000 - £800 = £1999,200 Transfer earnings is £800 Transfer earnings are what a factor of production can earn in its next best alternative use (opportunity cost of a factor performing its current role) Economic rent is the payment received by a factor of production over and above that which is needed to keep it in its present occupation Economic rent in terms of labour is total

 

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Economic rent and transfer earnings On the diagram the total earnings is wage x quantity of labour employed = 0QAW The supply curve represents the wage which is necessary to keep the corresponding numbers of workers in the market The area above the curve (WBA) is economic rent Transfer earnings is the area below the curve (0BAQ) The amount of economic rent earned by individual workers will differ The first worker taken on would have been prepared to work for much less than the wage rate so a relatively high proportion of his earnings will be economic rent The last worker employed would have been prepared to work only for the going wage rate and so earns no economic rent

 

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Economic rent and transfer earnings The proportion of earnings made up of economic rent depends on the elasticity of supply When supply is inelastic the economic rent will be high e.g. footballers, movie stars, investment bankers The diagram opposite shows the market for premier league football players Most footballers enjoy playing the game and would continue to do so even if their wage was reduced Most would earn much less in their next best paid jobs High demand for their skills is derived from high attendance figures and TV rights Both demand and supply is inelastic

 

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Trade Unions When we draw supply and demand diagrams to demonstrate how wages are determined we are assuming that this is a perfectly competitive market In reality there are few examples of highly competitive labour markets – all labour markets are imperfectly competitive to an extent The existence of trade unions is one reason for this If we introduce a trade union into the market they become the monopoly supplier of labour A Trade union is an organisation of workers who join together to further their own interests (they will collectively bargain for higher wages and better working conditions)

 

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Trade Unions The trade union bids up the wages from W1 to W2 The new supply curve is W2aS No workers will be willing to work for less than W2 Employment will fall from Q1 to Q2 While some workers are able to benefit from higher wages others may lose their jobs The wage increase that trade unions are able to secure for their members is known as the trade union mark up

 

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Trade Union membership trends Since Mrs Thatcher came to power in 1979 trade unions have declined significantly Part of the explanation is due to a decline in the manufacturing industry where powerful unions existed Several laws were passed to reduce their power Union membership tends to be higher in the public sector and manufacturing Full time workers are 50% more likely to belong to a trade union than part-time (large increase in part time workers)

 

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Employers with labour market power Firms who employ a high percentage of workers in a particular labour market can influence the wage rate An example is the government as the main employer of soldiers for national defence or teachers or nurses Monopsonists are price makers or wage makers –  they dictate the wage rate In the same way that the marginal cost curve was the monopolies supply curve the marginal cost of labour curve is the supply curve of labour The supply curve is the average cost of labour (AC L ) and tells us what wage the monopsonist must pay to attract labour The reason the supply curve is not the marginal cost curve this time is that each time the monopsonist raises the wages to attract another worker it has to pay all of the other workers the same amount (it has the cost of hiring the next worker and the cost of paying all the others the extra) A monopsonist is a single dominant buyer of labour – workers cannot choose between alternative employers D=MRP S=AC L MC L Real wage Employment Qm

 

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D=MRP S=AC L MC L Real wage Employment Qm The Monosonist employs labour where MC = MRP (above this point the marginal revenue is less than the marginal cost – the next worker is adding more cost than revenue)

 

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To find the wage that the Monopsonist has to pay we take the dotted line up to the supply curve In this instance the Monopsonist employs Qm at W1 D=MRP S=AC L MC L Real wage Employment Qm Wm

 

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If we compare this with the perfectly competitive market ( Qc,Wc ) we can see that the monopsonist employs less at a lower wage D=MRP S=AC L MC L Real wage Employment Qm Wm Qc Wc

 

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We can now introduce a trade union and see if, like the perfectly competitive labour market, employment levels drop The trade union will bit up the wages to W m+tu D=MRP S=AC L MC L Real wage Employment Qm Wm Wm+tu

 

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No worker will accept less than this wage so the supply curve is perfectly elastic at this point (even the monopsonist becomes a price taker) The supply curve then follows the normal supply curve (ACL) D=MRP S=AC L MC L Real wage Employment Qm Wm Wm+tu

 

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This creates a new kinked MC curve and gives us a new equilibrium point (where the MC curve cuts the MRP curve). D=MRP S=AC L MC L Real wage Employment Qm Wm Wm+tu Qm+tu

 

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We can see that this time the trade union has actually increased the number of employed from Qm to Qm+tu We use this theory to prove that a trade union does not always create unemployment (like it did in the pc labour market – see inset) D=MRP S=AC L MC L Real wage Employment Qm Wm Wm+tu Qm+tu

 

Videos: 

Videos Review this theory by watching the pajholden video http://www.youtube.com/watch?v=9TnuhpzhlsQ&feature=related And this one http://www.youtube.com/watch?v=HxFS4vH-mLw

 

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Wage differentials Wage differentials are the differences in wages arising between individuals, occupations, industries, firms and regions These occur when labour markets are not perfectly competitive The diagram below contrasts the market for surgeons and cleaners The supply of surgeons is low compared to demand due to lengthy training and high qualifications. Supply is also inelastic as a result An increase in wages will not result in an influx of surgeons in the short run Demand will also be inelastic due to the vital role they have – no substitute

 

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Wage differentials The supply of cleaners is high and elastic No qualifications are required or training The number of people able to do it will mean that an increase in wage rate will lead to a large extension in supply The marginal revenue product for cleaners is low meaning demand is low

 

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Other reasons for wage differentials Relative bargaining strength Surgeons working in the UK tend to be members of the BMA which has significant bargaining power In contrast cleaners have low bargaining power Government policy Minimum wage – this would have a positive impact on the pay of cleaners Public spending – spending has increased on health care with an ageing population increasing the demand for surgeons. This will increase the MRP of surgeons (MRP = D; if D increases W increases) Esteem if an occupation is held in high esteem (e.g. surgeon, vet, barrister) the perceived MRP will increase MRP of a cleaner is low as they are not held in high esteem Examiner’s tip – exam questions may ask why contrasting professions such as doctors versus nurses or footballers versus teachers are paid differently. You must concentrate on using economic theory to explain these differentials

 

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Wage differentials between different groups Skilled and unskilled workers Demand for skilled is higher MRP for skilled labour is higher More difficult to substitute skilled labour with capital equipment or unemployed workers Male and female workers Despite equal pay legislation men still earn more than women Partly explained because there are more women part time workers Historically women were less qualified A greater percentage work in low paid occupations A smaller percentage have trade union or professional organisation membership (less bargaining power) Some women miss out on promotion because they leave work to raise children Negative discrimination - employers undervalue MRP of female workers

 

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Wage differentials between different groups Part time and full time workers Part-time tend to receive less than full-time workers Supply of part time is high compared to demand Part time workers less likely to receive training Less bargaining power High percentage are women Ethnic origin Workers from ethnic minority groups on average earn less E.g. Pakistani workers -High proportion work in the catering industry where pay is low Qualifications are typically lower Discrimination is also a factor Complete activity P91

 

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Discrimination in the labour market Discrimination is where groups of workers are treated differently to other workers in the same job regarding pay and employment Discrimination is a cause of labour market failure and can be negative or positive Discrimination is illegal in the UK Negative discrimination occurs when a group of workers are treated less favourably than others Race, gender, age or disability are common causes for discrimination Prejudice leads employers to believe that the MRP of this group is lower than it is Discrimination predominantly affects the demand side of the labour market but can also affect the supply side Supply to non-discriminating firms will increase

 

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Discrimination costs Leads to lower pay for discriminated More difficulty in finding work Resort to taking jobs that they are overqualified for May not apply for promotion to senior positions Firms may have less workers to choose from increases production costs and may damage international competitiveness Higher costs passed on to consumers Economy wide costs Increase in government spending welfare benefits Cost of introducing legislation Examiner’s tip – exam questions could be set on the impact of gender, ethnic, age and disability discrimination on wages and levels employment

 

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Positive discrimination Firms may discriminate in favour of certain groups Employers perceive the MRP of a particular group of workers is higher than it actually is This results in the demand curve being further to the right than it should be as seen in the diagram below Thus some groups will earn higher wages than others of similar ability The government may also discriminate positively in order to offset negative discrimination Fig 8.11 P93