UNIT FOUR

WAGE DETERMINATION

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 Wage Determination under PC Product and Labor Markets

 In a PC labor market, the labor SS curve facing

each firm is horizontal.
 There are so many buyers and sellers in a PC
market that each buyer and seller is a price-taker.
 In this case, each firm may hire as many or as few
workers as it wishes at the established market
wage rate.
 Given the market SS of and the market DD for
labor now it is easy to determine the labor market
equilibrium.
This equilibrium is determined by the intersection of
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the two curves.


 The equilibrium wage rate is w* and the employment

level is L*.
 This is the same as the determination of price for a commodity.
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 The difference between commodity pricing and labor
pricing lies in the determinants of the DD for labor and the
method used to derive the SS of labor.
 Specifically,
1. Consumers demand commodities of the utility or
satisfaction they receive in consuming the commodities,
firms demand labor in order to produce the goods and
services demanded by the society.
2. consumers demand commodities, firms demand the
services of labor. That is, firms demand the flow of labor
services and not the stock of the labor itself.
3. The supply of labor is not determined by the cost of
production, but involves the attitudes of individuals
toward work and leisure.
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 Wage Determination and Monopolistic Exploitation
When firms have monopolistic power, labor is paid its
MRP, which is smaller than the VMPL.
 This effect is called monopolistic exploitation. It represents
the difference between the amount labor is paid under
perfect competition and the amount the same factor
(labor) is paid under the imperfection introduced to the
product market.

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 Wage Determination and Monopsonistic Exploitation
 Here we will examine the case of a firm that has
 monopolistic power in the product market and
 monopsonistic power in the input market.
 Suppose that the firm is the only buyer of the input (a
monopsonist).
 The supply of labor has a positive slope: as the
monopsonist expands the use of labor he/she must pay a
higher wage.
 The supply of labor shows the average expenditure or
price that the monopsonist must pay at different levels of
employment.
 Its slope is dw/dL which is greater than zero ( dw/dL > 0).
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

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 Multiplying the price of input by the level of employment gives
the total expenditure of the monopsonist for the input (TEL = w.
L).

  w = AEL = f (L)…The supply of labor the monopsonist

faces
 The relevant magnitude for the equilibrium of the monopsonist
is the marginal expenditure of purchasing an additional unit of
the factor. 9
 Profit is maximized by employing Les units of labor for
which MEL = MRPL.
 The wage rate that the firm will pay for the Les units of
labor.
 The wage rate and the employment of labor are lower
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than that of perfect competition.
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wC = wage rate paid under perfectly competitive product
and factor markets.
wM = wage rate paid under perfectly competitive factor
market and imperfectly competitive product market.
wS = wage rate paid under imperfectly competitive
product and factor markets.
wC > wM > wS (LC > LM > LS)
wC – wM is monopolistic exploitation
wC – wS is monopsonistic exploitation
 (wC – wM due to monopolistic power in the product market
 wM – wS solely due to monopsonistic power in the factor
market).
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 Bilateral Monopoly
 Bilateral monopoly arises when a single seller (monopolist)
faces a single buyer (monopsonist).
 All firms are organized in a single body that acts like a
monopsonist, while the labor is organized in a labor union
that acts like a monopolist.
 (a model in which the participants are two monopolies, one
on the supply side and one on the demand side).
 The solution to a bilateral monopoly situation is
indeterminate.
 The model gives only the upper and lower limits within
which the wage rate will be determined by bargaining.
 The outcome of the bargaining cannot be known13 with
certainty.
 It will depend on bargaining skills, political and economic
power of the labor union and the firms, and on many other
factors
 From the point of view of the monopolist (labor union)
this curve represents its average revenue curve (ARs).


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 Labor Union Facing PM Firms
 In this model it is assumed that the firm has neither a
monopoly nor a monopsony power.
 The labor force, however, is unionized and behaves like a
monopolist in the labor market.
 As in the case of bilateral monopoly, the supply curve
shows the marginal cost of the labor union.
 The market demand for labor DL is the aggregate VMPL
curve, which is derived from the summation of individual
firms demand curves.
 The curve is also the AR for the labor union (ARS), from
which the marginal revenue (MRS) can be derived using the
usual method.
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 Wage rate in the market depends only on the goals of the
labor union.
Three most commonly pursued goals by unions.
1. The maximization of the total gains/profit to the union
as a whole.
2. The maximization of employment. The highest level of
employment is defined by the intersection of the
demand for and the supply of labor.
3. The maximization of the total wage bill. If the union
aims at maximization of wage receipts.

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 Labor Unions and the Union Wage Advantage
 There are two major types of unions: industrial unions and
trade unions (trade unions are also known as craft unions).
 Industrial unions attempt to organize all of the workers in
an industry, regardless of the type of work that is done.
 Trade unions attempt to organize all of the workers
performing a particular type of job, regardless of the
industry in which the worker operates.
 In each unionized firm, workers are organized into shops,
groups of workers performing similar tasks. Each shop
votes on which union will serve as their bargaining agent
for collective bargaining purposes.
 Each shop is represented by only one union in negotiations
with the employer. 17
 Under a collective bargaining agreement, unions negotiate
a wage with the employer.
 An effective union negotiates a wage that is above the
equilibrium wage.

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 Unions are able to convince the government to pass laws that give
unions some control over labor supply.
 Since unions control the process of licensing, this gives unions
substantial ability to control labor supply in some industries.

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 As is the case with a collective bargaining agreement, a supply
restriction results in a higher wage (w') and a reduced level of
employment (L').
 The difference, though, is that there are no unemployed workers in
this market since the supply restriction prevents these additional
workers from ever appearing in this market.
Measuring the Union Wage Advantage
 The pure union wage advantage is the percentage by which the union
wage (Wu) exceeds the nonunion wage that would exist without the
union (Wn).

where
 A is the pure union wage advantage,
 Wu is the union wage and
 Wn is the nonunion wage. 20
 The measured union wage advantage may overstate or
understate the pure advantage depending on which of the
following effects are dominant.
 The Spillover Effect – refers to the decline in nonunion wages
that results from displaced union workers supplying their
services in nonunion labor markets.
 Because the spillover effect depresses observed nonunion wages, the
measured union wage advantage is larger than the pure wage
advantage causing the union wage advantage to be overstated.
 The Threat Effect – refers to an increase in nonunion wages
that a nonunion employer offers as a response to the threat of
unionization.
 This is because nonunion employers will feel increasingly threatened
with unionization when workers in union firms obtain wage increases.
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 The Product Market Effect – a union pay increase, through
its effect on costs and prices, shifts demand to firms in the
non-union sector.
The added demand for nonunion output is translated into added
demand for nonunion labor, which could have a pay-raising
influence.
 The Superior-Worker Effect – the higher wages paid by
union firms will cause workers to queue up for these “good”
union jobs.
 the availability of many job seekers, unionized employers will
carefully screen these prospective workers for those having the
greatest ability, the most motivation, the least need for costly
supervision, and other worker traits contributing to high
productivity.
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 Minimum Wage Laws
 Most of the increases in the minimum wage over time have been
designed to restore the real minimum to its past higher real values.
 The introduction of a minimum wage law that covers all employees
into a perfectly competitive labor market will be expected to result in
a reduction in employment.


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 An increase in the minimum wage need not result in
increased employment.
 As long as the workers who lose their jobs in the covered sector
are able to shift to work in non-covered firms.
 In general, the theories suggest that a minimum wage law
(or union) will result in:
 unemployment and economic inefficiency if the labor
market is perfectly competitive and there is complete
coverage, and
 economic inefficiency if the labor market is perfectly
competitive and there is a non-covered sector.

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 Theories of wage
(Reading Assignment)

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 !!!THAKS!!!

END OF CHPTER FOUR!!!

………በቃ………….

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