3.3. Wage Determination in a Labour Market and Perfect Imperfect Labour Market

Question 1

Labour Market Equilibrium Curve (DRAW)

Answer 1

• y-axis - real wage rate
• x-axis - quantity of labour
• demand of labour = MRP
• supply of labour
• equilibrium where demand and supply intersects

Question 2

Equilibrium in Labour Markets

Answer 2

when the demand for labour is equal to the supply of labour, the labour market clears and there is no tendency for change.

Question 3

Why are there changes in market wages

Answer 3

• Shifts in the demand for labour

- Shifts in the supply of labour

Question 4

Causes of shifts in the demand for labour

Answer 4

• Change in productivity of labour
• Change in price of the product
• Change in demand for the product
• Change in the price of a substitute for labour

Question 5

Causes of shifts in the supply for labour

Answer 5

• Change in the non-monetary factors in that labour market
• Change in the wage rates and non-monetary factors in other labour markets
• Change in the size of the labour force of the whole economy

Question 6

Economic rent and Transfer earnings on the Labour Market Equilibrium Curve (DRAW)

Answer 6

• Economic rent in the same place as producer surplus

- Transfer earnings the triangle below that

Question 7

Economic Rent

Answer 7

the extra payment received by a factor of production above what is needed to keep it in its present use.

Question 8

Transfer Earnings

Answer 8

the minimum payment needed to keep a factor of production (e.g. labour) in its current use.

Question 9

Economic Rent and Transfer Earnings when there is Elastic Supply of labour

Answer 9

Majority of the wage is made up of transfer earnings

Question 10

Economic Rent and Transfer Earnings when there is Inelastic Supply of labour

Answer 10

Majority of the wage is made up of economic rent.

Question 11

Economic Rent and Transfer Earnings when there is Perfectly Elastic Supply of labour

Answer 11

All of the wage is made up of transfer earnings.

Question 12

Economic Rent and Transfer Earnings when there is Perfectly Inelastic Supply of labour

Answer 12

All of the wage is made up of economic rent.

Question 13

Wage determination in a perfect labour market

Answer 13

1) Many workers, many small firms, all with no market power.
2) Firms are profit maximisers (MRP = MCL)
3) Workers are homogeneous (identical) and perfectly mobile
4) Workers and firms have perfect knowledge of market conditions
5) Workers and firms are wage takers – they accept the market wage.
6) No government intervention, no trade unions and no monopsony.

Question 14

Oerfect labour market curve (DRAW)

Answer 14

• y-axis - wage
• x-axis - quantity of labour
• MCL is set equal to the market wage equilibrium
• W = MCL = ACL = S
• MRP drawn
• For profit maximisation set quantity where MRP = MCL
• When MRP > wage = they can increase profits by employing more
• When MRP < wage = they can increase profits by employing less

Question 15

High wages (wage differentials)

Answer 15

1) High demand for labour: due to high marginal revenue product (MRP).
2) Inelastic demand for labour: difficult to replace, inelastic PED for product.
3) Low supply of labour: labour is very scarce.
4) Inelastic supply of labour: high skilled, a lot of training, difficult / high risk job.

Question 16

Low wages (wage differentials)

Answer 16

1) Low demand for labour: due to low marginal revenue product (MRP).
2) Elastic demand for labour: easy to replace, elastic PED for product.
3) High supply of labour: labour is abundant.
4) Elastic supply of labour: low skilled, little / no training, easy / low risk job.

Question 17

Government minimum wage

Answer 17

the lowest wage by law that can be legally
paid to labour
- set above the labour market curve equilibrium

Question 18

Government minimum wage diagram (DRAW)

Answer 18

y-axis = real wage rate
x-axis = quantity of labour

Before minimum wage:

• W* = wage
• Q* = quantity
• 0W*e = Economic rent
• 0eQ* = Transfer earnings

After minimum wage:

• Wmin = minimum wage
• s = quantity
• 0Wminca = economic rent
• 0as = transfer earnings
• ace = welfare loss

Supply curve is WminbS

Question 19

Trade Union

Answer 19

an organisation representing workers that tries to improve wages, working conditions and worker rights through “collective bargaining”.

Question 20

Trade Union Aims

Answer 20

• Negotiate on behalf of its members.
• Higher pay.
• Better working conditions.
• Protect against unfair dismissal.
• Promote workplace training.
• Protect worker pensions.

Question 21

Trade Union Diagram (DRAW)

Answer 21

bascially same of minimum curve diagram

- but instead of Wmin it is Wtu

Question 22

Trade Union other diagram - supply (DRAW)

Answer 22

y-axis = real wage rate
x-axis = quantity of labour
- supply of labour shifting left

Question 23

What determines the strength of a trade union

Answer 23

1) Size of the trade union:
- larger size → more TU power.
2) Trade union membership as a proportion of total market labour supply:
- higher proportion → more TU power.
3) Elasticity of demand for labour / product:
- inelastic demand for labour / product → more TU power.
Profitability of the employer:
- more profitable → more TU power.

Question 24

Monopsony

Answer 24

a single buyer in a market (i.e. the only employer in a labour market) e.g. government is a monopsony employer of police.

Question 25

Monopoly vs Monopsony

Answer 25

Monopoly
- A single seller in a market.
- Sell at high prices
Monopsony
- A single buyer in a market.
- Buy at low prices.

Question 26

Monopsony Diagram (DRAW)

Answer 26

y-axis = real wage rate
x-axis = quantity of labour
- SL = ACL curve
- DL = MRP curve
- MCL curve
- quantity of labour set to profit maximising condition (MCL = MRP)
- both quantity labour and wage rates low, below equilibrium
- there is welfare loss

Wm < Wplm
- A monopsonist pays a lower wage than a perfect labour market
Qm < Qplm
- A monopsonist employs fewer workers than a
perfect labour market.

Question 27

Bi-lateral monopoly

Answer 27

a market structure where there is a monopsony (only buyer) and a monopoly (only seller, i.e a trade union).

Question 28

Bi-lateral Monopoly Diagram (DRAW)

Answer 28

y-axis = real wage rate
x-axis = quantity of labour
- SL = ACL curve
- DL = MRP curve
- MCL curve
- Wtu wage set by trade union is set below equilibrium
- wages become higher
- both quantity labour and wage rates low, below equilibrium
- there is welfare loss

Wm < Wtu
- A trade union will increase wages in a monopsony labour market.
Qm < Qtu
- A trade union will increase employment in a monopsony labour market.