05. lmequil (2008)
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Labor Market EquilibriumLabor Market Equilibrium
Workers prefer to work when the wage is high,Workers prefer to work when the wage is high,and firms prefer to hire when the wage is low.and firms prefer to hire when the wage is low.
Labor market equilibrium ³balance out´ theLabor market equilibrium ³balance out´ the
conflicting desires of workers and firms andconflicting desires of workers and firms and
determines the wage and employment observeddetermines the wage and employment observed
in the labor market.in the labor market.
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1. Equilibrium in a Single Competitive Labor Market1. Equilibrium in a Single Competitive Labor Market
The supply curve gives theThe supply curve gives the
total number of employeetotal number of employee--hours that agents in thehours that agents in theeconomy allocate to theeconomy allocate to themarket at any given wagemarket at any given wage
level; the demand curvelevel; the demand curvegives the total number of gives the total number of employeeemployee--hours that firmshours that firmsin the market demand atin the market demand atthat wage. Equilibriumthat wage. Equilibriumoccurs when supply equalsoccurs when supply equalsdemand, generating thedemand, generating thecompetitive wagecompetitive wage ww * and* andemploymentemployment E E *.*.
Equilibrium in a Competitive Labor Market
Employment
Dollars
E*
W*
D
S
Note: There is no unemployment in a
competitive labor market. Persons
who are not working are also not
looking for work at the going wage.
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2. Competitive Equilibrium Across Labor Markets2. Competitive Equilibrium Across Labor Markets
The economy typically consists of many labor markets, even for
workers who have similar skills. As long as either workers or firmsare free to enter and exit labor markets, a competitive economy will
be characterized by a single wage.
Dollars
Employment
D N
S¶ N
W*
Dollars
Employment
DS
S¶S
W*
S N
W N
SS
WS
Competitive Equilibrium in Two Labor Markets Linked by Migration
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Note: The ³single wage´ property of Note: The ³single wage´ property of competitive equilibrium has importantcompetitive equilibrium has importantimplications for economic performance. Thatimplications for economic performance. Thatis, workers of given skills have the same valueis, workers of given skills have the same valueof marginal product of labor in all markets.of marginal product of labor in all markets.The allocation of workers to firms whichThe allocation of workers to firms whichequates the value of marginal product acrossequates the value of marginal product across
markets is also the allocation which maximizesmarkets is also the allocation which maximizesnational income. This type of allocation isnational income. This type of allocation iscalled ancalled an efficient allocationefficient allocation..
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3. Policy Application: Payroll Taxes3. Policy Application: Payroll Taxes
Payroll taxes on employers are heavily used in thePayroll taxes on employers are heavily used in thesocial insurance area. With our simple labor model,social insurance area. With our simple labor model,we can show that the party making the socialwe can show that the party making the socialinsurance payment is not necessarily the one thatinsurance payment is not necessarily the one that bears the burden of the tax. bears the burden of the tax.
Tax
Employment
S0
D0
D1
R eal Wage
E0E1
E2
W1
W0
W1+X
W0+
Tax is a fixed dollar amountX
.D0D1
with vertical distance of X.
pt. A: excess supply real wage
Employees bear part of the burden of the
payroll tax in the form of lower wage
rates and lower employment levels.
Note: In general, the extent to which the
labor supply curve is sensitive to wages
determines the proportion of the employer
payroll tax that gets shifted to employee¶s
wages.
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4. The Cobweb Model4. The Cobweb Model
Our analysis of labor market equilibrium assumes that marketsOur analysis of labor market equilibrium assumes that marketsadjust instantaneously to shifts in either supply or demandadjust instantaneously to shifts in either supply or demand
curves, so that wages and employment change swiftly from thecurves, so that wages and employment change swiftly from the
old equilibrium levels to the new equilibrium level. Manyold equilibrium levels to the new equilibrium level. Many
labor markets, however, do not adjust so quickly to shifts inlabor markets, however, do not adjust so quickly to shifts in
the underlying supply and demand curves.the underlying supply and demand curves.
Example: the Engineering MarketExample: the Engineering Market
Note: The adjustment of college enrollments to changes in the Note: The adjustment of college enrollments to changes in the
returns to education is not always smooth or rapid, particularlyreturns to education is not always smooth or rapid, particularly
in fields that are highly technical.in fields that are highly technical.
The inability to respond immediately to changed market The inability to respond immediately to changed market
conditions can cause boomconditions can cause boom--andand--bust cycles in the market for bust cycles in the market for
highly technical workers.highly technical workers.
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Wage
Number of Engineers
D¶
S
D
N0 N2
N3 N
1
W2
W0
We
W3
W1
Demand increase to D¶; temporary supply is N0. W increase to W1
W1
wage induce increase in supply to N1 excess supply
W reduce to W2
W2
wage reduce supply to N2
W increase to W3
at W3
, supply increase to N3
excess supply W reduces, etc.
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Overtime the swings become smaller and eventuallyOvertime the swings become smaller and eventually
equilibrium is reached. cobweb model.equilibrium is reached. cobweb model.
Note: There are two key assumptions in the cobweb model: Note: There are two key assumptions in the cobweb model:
1.1. It takes time to produce new engineers, so thatIt takes time to produce new engineers, so thatthe supply of engineers can be thought of asthe supply of engineers can be thought of as
being perfectly inelastic in the short run. being perfectly inelastic in the short run.
2.
2. Students are very myopic when they areStudents are very myopic when they areconsidering whether to become engineers.considering whether to become engineers.
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5. Policy Application: The Impact of Minimum Wages5. Policy Application: The Impact of Minimum Wages
The standard economic model of the impact of The standard economic model of the impact of
minimum wages on employment is illustrated in theminimum wages on employment is illustrated in thefollowing figure:following figure:
Dollars
E*
W*
D
S
ES
W
E
The Impact of the Minimum Wage on Employment
Note: A minimum wage
creates unemployment
both because some previously employed
workers lose their jobs,
and because some workers
who did not find it
worthwhile to work at the
competitive wage find it
worthwhile to work at the
higher minimum wage.Employment
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The Covered and Uncovered Sectors
Dollars
EC
W*
DC
SC
W
EmploymentE
(a) Covered Sector
The Impact of Minimum Wages on the Covered and Uncovered Sectors
Dollars
EU
W*
DU
SU
Employment
(b) UNcovered Sector
S¶U
S´U
E¶UE´U
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Note: In the absence of a minimum wage, the Note: In the absence of a minimum wage, themigration of workers across sectors equates themigration of workers across sectors equates the
wage in the two sectors. The migration of wage in the two sectors. The migration of
workers when the wage in one of the marketsworkers when the wage in one of the markets
is set at the minimum wage equates theis set at the minimum wage equates the
expected wage across sectors. I.e., the freeexpected wage across sectors. I.e., the free
migration of workers across sectors ensure thatmigration of workers across sectors ensure that
the expected wage in the covered sector equalsthe expected wage in the covered sector equalsthe for the for--sure wage in the uncovered sector.sure wage in the uncovered sector.
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6. Noncompetitive Labor Markets6. Noncompetitive Labor Markets
(1)(1) MonopsonyMonopsony
Because the firm is the only demander of labor inBecause the firm is the only demander of labor in
this market, it can influence the wage rate.this market, it can influence the wage rate.
Monopsnoists face an upwardMonopsnoists face an upward--sloping supply curve.sloping supply curve.
This is because the supply curve confronting themThis is because the supply curve confronting them
is the market supply curve.is the market supply curve.
Note: To expand its work force, a monopsonist must Note: To expand its work force, a monopsonist mustincrease its wage rate, i.e., the marginal cost of increase its wage rate, i.e., the marginal cost of
hiring labor excess the wage.hiring labor excess the wage.
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To maximize profits, we know that any firm should hire
labor until the points at which marginal revenue product
equals marginal cost.MR P = MCL
W
L
MR P
S
MCL
Em Ec
Wm
WC
Wages are below marginal
revenue product for a
monopsonist.
Wm
< WC
and Em
< EC
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(2)(2) MonopolyMonopoly
A monopoly trying to maximize profits and facing aA monopoly trying to maximize profits and facing a
competitive labor market will hire workers until itscompetitive labor market will hire workers until itsmarginal revenue product equals the wage rate:marginal revenue product equals the wage rate:
MR P = (MPMR P = (MPLL)(MR ) = W)(MR ) = W
(MR/P)(MR/P)(MP(MPLL) = (W/P)) = (W/P)<1<1
The demandThe demand--for for--labor curve for a firm that haslabor curve for a firm that hasmonopoly power in the output market will lie belowmonopoly power in the output market will lie below
and to the left of the demandand to the left of the demand--for for--labor curve for anlabor curve for anotherwise identical firm that takes product prices asotherwise identical firm that takes product prices asgiven.given.
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Note: The wage rates that monopolies pay are not necessarily
different from competitive levels even though employment levels
are. An employer with a product market monopoly may still be a
very small part of the market for a particular kind of employee, and
thus be a price taker in the labor market even though a price maker
in the product market.
Employment
Dollars
The Labor Demand of a Monopolist
VMPE
MR PE
WA
Em E*
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