Labor

Lecture 4
Chapter 13, Sections 13.6, 13.7
Navin Kumar & Sheng-Hao Lo
Harris School of Public Policy

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Introduction

I In the previous class, we’ve assumed that firms are

price-takers in factor market - they take the prices of inputs
as given
I But some firms clearly have market power
I E.g. Pepsi and Coca-Cola, Target and Walmart, Apple and
Samsung
I Each of these firms is so large that it can influence not only
the prices buyers will pay for its product, but also the prices
each pays to its factor suppliers
I A monopsony is a firm that is the sole buyer of a good
I Monopsony power is a broader idea
I Refers to firms having market power in a particular factor
market
I E.g. In any particular geographical area, there is only one
organization hiring firefighters - but people can move!

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Labor supply for a perfectly competitive firm

Wage, MRPL
I Perfectly competitive firms
can buy any amount of an
output at market wage W
W Ls

MRPL
Quantity

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Labor supply for a monopsonist

I A monopsonist sees the

Wage, MRPL
entire market Ls
I Analogous to
monopolist: sees the
entire market as well
I If they wish to increase
amount of labor they use,
they need to increase
wages
I (As we’ll see, you need not
feel bad for them!) MRPL
Quantity

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Marginal expenditure for a perfectly competitive firm

Wage, MRPL
I Marginal expenditure: the
cost of buying an
additional unit of an input
I For a perfectly competitive
firm, the marginal
expenditure on a unit of W ME
labor is W

MRPL
Quantity

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Marginal expenditure for a monopsony

W Employees QL TC ME
25,000 - 0 0 0
30,000 Alice 1 30,000 30,000
35,000 Alice, Bob 2 70,000 40,000
40,000 Alice, Bob, Charlie 3 120,000 50,000
I Not so for a monopsony!
I Not only is the ME rising - it is rising faster than the wage!
I This occurs because while raising the wage to attract the
new employee, the firm ended up having to also increase
the wage of the old employees
I ME = Wage of new employee + pay bump for old
employees

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Marginal expenditure for a monopsonist

Wage, MRPL
ME Ls

I For a monopsonist, the ME

curve is above the labor 40
supply curve

35

MRPL
2 Quantity

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Optimization

Wage, MRPL
I MRPL : The extra revenue
that the firm gets from ME Ls
hiring an additional unit of
labor
I ME: The extra cost
incurred by hiring an
additional unit of labor
I Claim: firms will produce at
the quantity of labor where
MRPL = ME MRPL
l∗ Quantity

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Argument

Wage, MRPL
ME Ls

I Suppose that the firm

Unrealized Profits
produces at some l < l ∗
I Here, ME < MRPL
I This gap is profit that the
firm could have earned

MRPL
l Quantity

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Argument

Wage, MRPL
ME Ls
I Suppose that the firm
produces at some l > l ∗
Loss
I Here, ME > MRPL
I This worker costs the firm
more to hire than they get
from the sale of goods
produced by that worker

MRPL
l Quantity

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Wage

Wage, MRPL
ME Ls
I The firm pays workers just
enough to secure l ∗ units
of labor
I According to the labor
supply schedule, the wage
is w ∗ w∗

MRPL
l∗ Quantity

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Welfare

Wage, MRPL
I Consider the worker at l
I It costs $b to hire them ME Ls
I However, they produce
goods worth $a
I A social planner would hire a
them, but the monopsonist
would not b
I Thus the social welfare
that would be gained by
hiring them is not realized MRPL
l Quantity

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Deadweight loss

Wage, MRPL
ME Ls
I The socially optimal level
of hiring is l o
I Each worker between l ∗
and l o would’ve generated
social welfare, but doesn’t DWL

I The deadweight loss is the

red region

MRPL
l∗ lo Quantity

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Why it matters

I Monopsony power especially matters with the provision of

publicly funded goods.
I Some labor markets where a state may have monopsony
power:
I Police
I Firefighters
I Teachers
I Doctors and nurses (in some countries)
I Some of these professions are associated with significant
externalities
I Low wages could reduce the number of people entering
these professions

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Potential solutions

I Minimum wage
I Potential answer for the minimum wage puzzle
I A public body that sets wages
I E.g. India has the the Pay Commission, an independent
body that sets the salary structure
I Possible problem: limited information, regulatory capture
I Labor unions

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Monopoly

I In some industries, labor

unions behave like a

Wage
monopoly
I Same effects as regular
monopolies: set the wage
w∗
above the social optimal
level, leading to too little MC
hiring, deadweight loss,
etc.
I They may function as a LD
MR
counterweight to
monopsonies l∗ Quantity

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Monopoly

I However, it is usually very

Wage
difficult for a union to know
what the marginal costs of
their members actually are
I The union may instead try
to maximize total wages wm MC
I This occurs when MR = 0
I Union dues are often
based on total income LD
I Smaller deadweight loss
lm Quantity

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Some topics in labor
Not in textbook

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Nominal wage rigidity

I In most markets, a
decrease in the demand

Price
S
for a good would lead to a
decrease in the price of the
good
p
I When the demand falls,
sellers bid down the price p0
of the good, inducing D
sellers to leave and buyers
to enter the market
I No excess supply D0
q0 q Quantity

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Nominal wage rigidity

I In the labor market, wages

do not adjust downward
easily
LS

Wage
I Workers dislike pay cuts
I Contracts usually cannot
be renegotiated, only
terminated Unemployment
w
I When economies go into
recession, demand for
labor falls, wages don’t
I Unemployment occurs
I Inflation lowers real wage LD
without lowering nominal
l 00 l Quantity
wage

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Search friction

I No two workers are alike - nor are any two jobs!

I The labor market can be thought of as workers and
employers seeking a good job match
I Some implications:
I There is a certain “natural” number of unemployed workers
and vacancies - workers will quit/be fired from jobs they are
not suited for
I Unemployment may persist due to mismatches in skill,
locations, compensation, etc
I When a match is found, we have a two-sided monopoly: the
worker and firm negotiate the terms (i.e. division of the
surplus generated by the match)

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Discrimination

I Definition: A situation in which equally productive persons

are treated unequally on the basis of an observable
characteristic
I Examples: on the basis of race, gender, caste, religion, etc
I Evidence comes from resume studies
I Mullainathan and Bertrand (2004) sent fictitious resumes to
help-wanted ads in Boston and Chicago
I Resumes were randomly assigned African-American
sounding names or White-sounding names
I White names received 50 percent more callbacks for
interviews

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Discrimination

I Why does discrimination persist?

I Employers who discriminate face higher costs than
employers who don’t
I e.g. less likely to successfully match
I Should be driven out of the market
I Taste-based discrimination: Customers prefer to interact
with people from a certain social category
I Employees that are discriminated against may have to work
harder for the same wage for the same work as their peers
I Recent papers find less discrimination in non-consumer
facing jobs

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Discrimination

I Statistical discrimination: Firms are inferring unknown

productivity from the social category
I Productivity is hard to know in advance
I Imperfect information about applicants they interact with
I Workers send signals about their productivity but signals
are noisy
I Firms use statistical info to infer applicants’ productivity
I Some social categories have lower productivity initially (due
to poverty, historic discrimination, etc)
I The social category is used as part of the decision making
process

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Discrimination

I Statistical discrimination: Firms are inferring unknown

productivity from the social category
I Results in deadweight loss due to under-placement of
discriminated against groups
I Can lead to a vicious circle as members of this group are
discouraged from participating in the market, or improving
their skills
I More applications in Labor Economics!
I A 10-week elective course
I BUSN 33918: Topics in Labor Economics
I ECON 34430: Topics in Labor Markets: Earnings and
Employment

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