Chapter 18 - The interaction of labour markets Flashcards
How does labour market equilibrium work?
Bringing demand and supply curves together for an industry shows how the equilibrium wage is determined for a particular type of labour. A diagram shows a downward-sloping labour demand curve (D) based on marginal productivity theory, and an upward-sloping labour supply curve (S). Equilibrium is found at the intersection of demand and supply. If the wage is lower than W* employers will not be able to fill all their vacancies, and will have to offer a higher wage to attract more workers. If the wage is higher than W* there will be an excess supply of labour, and the wage will drift down until W* is reached and equilibrium obtained.
How does an increase in demand for labour affect labour market equilibrium?
Suppose there is an increase in the demand for the firm’s product. This will lead to a rightward shift in the demand for labour, say from D0 to D1 in the diagram. This in turn will lead to a new
market equilibrium, with the wage rising from W0 to W1. This leads to an
extension in supply, with employment rising from L0 to L1.
How does an increase in supply of labour affect labour market equilibrium?
Suppose that there is an increase in the number of trained web designers looking for work, following an expansion in the number of courses provided in colleges. How will this affect the market for web designers? The diagram illustrates. An increase in labour supply shifts the supply curve from S0 to S1, with the equilibrium wage falling from W0 to W1 and the quantity of labour increasing from L0 to L1. There has been an extension of demand.
How do wage differentials work?
It is clear from looking at the real world that there exist wage differentials between individuals. Surgeons and butchers earn different amounts, as do labourers and rocket scientists. There are a number of reasons why this is the case and will always be so.
One reason, of course, is that different workers display different marginal physical products. Some may have skills resulting from innate ability and talents or from the education or training they have received. Firms will value the workers who show the skills and productivity that they require in their workforce.
Different occupations pay different wage or salary levels - which partly, of course, reflects the different marginal productivities of the occupations. We may also observe wage differentials between different locations. Wage and salary levels in London and the southeast are higher than in Northern Ireland, for example. These differences are important, and may reflect variations in market conditions between local or regional labour markets.
How does discrimination affect wage differentials?
We have seen that wage differentials across different labour markets within an economy such as the UK are to be expected because of differences in marginal productivity of different workers, and differences in economic rent and transfer earnings. However, the question often arises as to whether such economic analysis can explain all of the differentials in wages that can be observed.
The mere fact that there is inequality does not prove that there is discrimination. You have seen the way in which education and training affects earnings, so differentials between different groups of people may reflect the different educational choices made by those different groups. The gender gap may also reflect the fact that childcare responsibilities interrupt the working lives of many women. This is important in terms of training and the build-up of experience and seniority. The increasing introduction of creche facilities by many firms is reducing the extent of this contribution to the earnings gap, but it has not eliminated it. In addition, there have been changes in social attitudes towards female education beyond the age of 16. When girls were expected to become homemakers, education beyond 16 was not highly valued, so there were generations of women who missed out on education, and consequently found themselves disadvantaged in the labour market. Although attitudes have changed, however, such effects take a long time to work their way through the system.
How does market failure occur in labour markets?
As with product markets, there are many ways in which labour markets may fail to achieve the most desirable results for society at large. Such market failure can occur on either the demand or the supply side of the market. On the demand side, it may be that employers - as the buyers of labour - have market power that can be exploited at the expense of the workers. Alternatively, it may be that some employers act against the interests of some groups of workers relative to others through some form of discrimination in their hiring practices or wage-setting behaviour. On the supply side, there may be restrictions on the supply of some types of labour, or it may be that trade unions find themselves able to bid wages up to a level that is above the free market equilibrium.
What is a monopsony?
A market in which there is a single buyer of a good, service or factor of production.
What is the evaluation of monopsony?
Monopsony has an impact on the labour market in two key ways. Workers will receive lower wages than they would have under perfect competition. Furthermore, fewer workers will be employed.
The relative size of these impacts will depend upon the elasticity of demand for and supply of labour. In a market where the demand for labour is relatively wage inelastic, the extent to which wages and employment can be forced down will be less than where demand is wage-elastic.
The elasticity of labour supply is also important. If workers can find employment elsewhere, then the supply of labour will be relatively elastic, and the monopsony employer will have less power to drive wages down. However, where workers have limited (or no) alternative employment opportunities, the monopsonist will have greater power in the market, and will be able to offer lower wages relative to the competitive outcome.
How would monopsony work in a product market?
As with a monopoly producer, the Competition and Markets Authority (CMA) monitors markets where there is a possibility that firms will abuse their market power, so has the authority to intervene in monopsony situations. A prominent example in a product market has been the CMA’s investigation of the buying power of supermarkets, which have been accused of driving down prices for their suppliers. This reflects the way in which monopsonistic power could be misused.
What is a trade union?
An organisation of workers that negotiates with employers on behalf of its members
What are the 3 main objectives of a trade union?
- Wage bargaining
- The improvement of working conditions
- Security of employment for their members
How do trade unions restrict labour supply?
If the firm faces a trade union that is limiting the amount of labour available to just L1, then the union will be able to push the wage up. This might happen where there is a closed shop: in other words, where a firm can employ only those workers who are members of the union. A closed shop allows the union to control how many workers are registered members, and therefore eligible to work in the occupation.
In this situation the union is effectively trading off higher wages for its members against a lower level of employment. The union members who are in work are better off — but those who would have been prepared to work at the lower wage either are unemployed or have to look elsewhere for jobs. If they are unemployed, this imposes a cost on society. If they are working in a second-choice occupation or industry, this may also impose a social cost, in the sense that they may not be working to their full potential. The extent of the trade-off depends crucially on the elasticity of demand for labour. When the demand for labour is relatively more elastic, the wage paid by the firm increases to W, whereas with the relatively more inelastic demand for labour, the wage increases by much more.
This makes good intuitive sense. The elasticity of demand is likely to be low in situations where a firm cannot readily substitute capital for labour, where labour forms a small share of total costs, and where the price elasticity of demand for the firm’s product is relatively low. If the firm cannot readily substitute capital for labour, the union has a relatively strong bargaining position. If labour costs are a small part of total costs, the firm may be ready to concede a wage increase, as it will have limited overall impact. If the demand for the product is price inelastic, the firm may be able to pass the wage increase on in the form of a higher price for the product without losing large volumes of sales. Therefore, these factors improve the union’s ability to negotiate a good deal with the employer.
How do trade unions negotiate wages?
A trade union’s foremost function can be regarded as negotiating higher wages for its members. In the absence of union negotiation, the equilibrium for the firm is where demand and supply intersect.
If the trade union negotiates a wage of W, the firm cannot hire any labour below that level. The firm now employs only L labour at this wage. So, again, the effect is that the union negotiations result in a trade- off between the amount of labour hired and the wage rate. Notice that there is nothing to stop the employer paying a wage that is higher than W, so to hire more than N workers, the employer would have to offer higher wages in order to attract workers into jobs.
The elasticity of demand for labour again affects the outcome. This time, with the relatively more inelastic demand curve D1, the effect on the quantity of labour employed is much less than when demand is relatively more elastic.
How do trade unions working conditions and job security?
One possible effect of trade union involvement in a firm is that workers will have more job security: in other words, they may become less likely to lose their jobs with the union there to protect their interests. From the firm’s point of view, there may be a positive side to this. If workers feel secure in their jobs, they may be more productive, or more prepared to accept changes in working practices that enable an improvement in productivity. For this reason, it can be argued that in some situations the presence of a trade union may be beneficial in terms of a firm’s efficiency. Indeed, the union may sometimes take over functions that would otherwise be part of the responsibility of the firm’s human resource department.
What is a bilateral monopoly?
A situation in which a monopoly seller of labour (a trade union) faces a monopsony buyer of labour (an employer)
What is the evaluation of bilateral monopoly?
In this situation, the market power of the two protagonists works against both of them to produce an outcome that is closer to perfect competition. It is not possible to predict where the final resting place for the market will be, but it will lie somewhere between Lm and L*, depending upon the relative strengths and negotiating skills of the firm and the union.
Given the decline in trade union membership and the weakened power of trade unions in the UK, it may well be the case that it is the firm that has more strength in these negotiations. In any event, as has been noted, the focus of trade union activity has tended to be more upon working conditions than on wages.
Why is labour market flexibility important?
If an economy is to maintain international competitiveness of its goods and services, an essential ingredient is that the labour market is flexible.
At the microeconomic level, where a prime concern is with achieving a good allocation of resources for society, the issue is whether workers can transfer readily between activities to allow resource allocation to change through time. This requires a number of conditions to be met. Workers need to have information about what jobs are available (and, perhaps, where those jobs are available), and what skills are needed for those jobs. Employers need to be able to identify workers with the skills and talents that they need. If workers cannot find the jobs that are available, or do not have the appropriate skills to undertake those jobs, the market will not function smoothly. Similarly, if employers cannot identify the workers with the skills that they need, that too will impede the working of the market.
Arguably, the problem has become acute in recent years, with a change in the balance of jobs between skilled and unskilled workers. As the economy gears up to more hi-tech activities, and low-skill jobs are outsourced or relocated to other countries, the need for workers to acquire the right skills becomes ever more pressing.
How is occupational mobility and information a policy to improve the flexibility of the labour market?
The process of structural change in an economy may be impeded if the people looking for work, perhaps because they have been released from a declining sector, do not have the requisite skills for the sectors that are expanding. It is also important for unemployed workers to have good information about the jobs available.
Successive governments have been aware of this issue, and have introduced measures to provide opportunities for workers to undergo training and incentives for employers to provide it. The latest policy in this area is the apprenticeship levy, which was introduced in April 2017. This attempts to overcome the free-rider problem, and has set a target of having 3 million apprentices in place by 2020. Large employers are required to make a payment into an online service account, but can reclaim their levy payments (plus a subsidy) when they take on apprentices into approved schemes. Employers who benefit by recruiting trained workers from other firms will not be able to reclaim their levy payments. Smaller employers (with wage bills below £3 million) can claim subsidies towards the costs of taking on apprentices.
How is trade union reform a policy to improve the flexibility of the labour market?
By negotiating for a wage that is above the equilibrium level, trade unions may trade off higher wages for lower levels of employment. the potential disruption caused by a strike action can also impede the workings of a labour market.
One of the most telling criticisms of trade unions has been that they have affected the degree of flexibility of the labour market. The most obvious manifestation of this is that their actions limit the entry of workers into a market.
This may happen in any firm, where existing workers have better access to information about how the firm is operating, or about forthcoming job vacancies, and so can make sure that their own positions are safeguarded against newcomers. This is sometimes known as the insider-outsider phenomenon. Its effect is strengthened and institutionalised by the presence of a trade union, or by professional bodies such as the Royal College of Surgeons.
This and other barriers to entry erected by a trade union can limit the effectiveness and flexibility of labour markets by making it more difficult for firms to adapt to changing market conditions.
Trade union membership has declined substantially in recent decades. This may partly reflect reforms brought in to curb the power of the unions and make it more difficult to call strike action. Also significant is that traditionally union membership has been higher in the manufacturing sector than in service sectors. The decline of manufacturing may therefore have reduced the power of the unions.
How does asymmetric information lead to information failure in labour markets?
The issue arises from the employer’s perspective. When an employer is hiring new workers, a key concern is the quality of the workers applying for jobs. This is partly a question about their innate talents and abilities. It can be overcome to some extent by checking applicants’ qualifications—indeed, this is why employers may insist on qualifications, even if they are not directly related to the requirements of the job.
However, there are other differences between workers that are important. Two workers with the same qualifications may show very different productivity. Some workers are naturally hardworking and conscientious, whereas others are always taking rest breaks and getting away with as little effort as possible. At the hiring stage, the employer may not be able to distinguish between the ‘workers’ and the ‘shirkers’.
Suppose a firm pays a wage that is the average warranted by workers and shirkers combined. As time goes by, some workers are likely to quit and go to higher-paid jobs with other firms. The employees who are most likely to leave are the more productive ones, who realise that if they are paid the average of what is right for the workers and shirkers taken together, they are being paid less than their own value. In the long run, the employer could be left with just the shirkers.
A rational response to this from the employer’s perspective is to pay a wage that is higher than the average, in order to encourage the productive workers to stay with the firm. This has the additional benefit of increasing the penalty for being caught shirking (since a worker faces a greater opportunity cost of getting the sack if wages are higher). So, paying a higher-than- average wage has an additional incentive effect in that it discourages shirking.
This higher-than-average wage is known as the efficiency wage, and can be seen as a response by firms to the asymmetric information problem. One of the results in the labour market is to raise the level of involuntary unemployment, in the sense that at the higher wage there will be an increase in the number of workers who would be prepared to accept a job but are unable to find employment.
How is geographic mobility a policy to improve the flexibility of the labour market?
In the UK, there are significant variations in labour market conditions between regions, reflected in wage differentials. Will workers migrate from one region to another in search of higher earning opportunities? Not always.
There are a number of reasons that help to explain why workers may not be freely mobile between different parts of the country. It could be that the workers who are available are located in areas remote from where the vacancies are appearing. If the available workers are living in Leeds, but the vacancies are in London, then they may not respond to the higher wages on offer, given the costs of transport and moving house - or the difficulty of finding out that the jobs are available. There may also be social effects — people do not like to move away from their friends and relatives, or to leave the area that they know or where their favourite football team plays. Parents may not wish to disrupt their children’s education.
The relatively high rate of owner-occupied housing in the UK means that workers who are owner-occupiers may need a strong inducement to move to another part of the country in search of jobs. For council house tenants, too, it may be quite difficult to relocate to a different area for employment purposes because they will have to return to the bottom of the waiting list for housing. Differences in house prices in different parts of the country add further to the problem of matching workers to jobs.
There may also be information problems, in that it may be more difficult to find out about job availability in other areas. The internet may have reduced the costs of job search to some extent, but it is still easier to find jobs in the local area, where the reputation of firms is better known to locals. Where both partners in a relationship are working, this may also make it difficult to find jobs further afield that would suit both of them, and there is some evidence that females tend to be less geographically mobile than males.
How is regional policy a policy to improve the flexibility of the labour market?
There have always been differences in average incomes and in unemployment rates between the various regions of the UK. In broad terms, there are two possible responses to this — either persuade workers to move to regions where there are more jobs, or persuade the firms to move to areas where labour is plentiful. The geographic immobility of workers has already been discussed, but how about persuading firms to move to regions where labour is available?
Some measures have been taken to encourage firms to consider relocating to regions where labour is available. These have included leading by example, with some civil service functions being moved out of London.
EU funding has helped in this regard, with Scotland, Wales and Northern Ireland all qualifying for grants. Between 1999 and 2012, Regional Development Agencies (RDAs) set up by the Labour government had responsibility for promoting economic development in their regions. The RDAs were abolished as part of government efforts to reduce the budget deficit, and ceased operating in March 2012.
During the course of the 2010 Coalition Government, George Osborne, the then-Chancellor of the Exchequer, launched the concept of the Northern Powerhouse. This was a strategy designed to provide funding to revitalise cities in the north of England, devolving powers from Westminster to local people, providing funds for locally determined projects, and spending £13 billion on improving transport infrastructure.
How is technology a policy to improve the flexibility of the labour market?
One of the greatest fallacies perpetuated by non-economists is that technology destroys jobs. Bands of labourers known as Luddites rioted between 1811 and 1816, destroying textile machines, which they blamed for high unemployment and low wages. In the twenty- first century there is a strong lobbying group in the USA arguing that outsourcing and cheap labour in China are destroying US jobs. President Trump has reinforced this message in his tweets, and used this argument to justify the imposition of tariffs on imports of a range of products from China. The tariffs were later extended to apply to other trading partners of the USA.
In fact, new technology and an expansion in the capital stock should have beneficial effects - so long as labour markets are sufficiently flexible. Consider a market in which new technology is introduced. If firms in an industry invest in technology and expand the capital stock, this affects the marginal revenue product of labour and hence the demand for labour, where demand shifts from D1 to D2. In this market, the effect is to raise the wage rate from W1 to W2 and the employment level from L1 to L2.
However, it is important to look beyond what happens in a single market, as the argument is that it is all very well expanding employment in the technology sector - but what about the old industries that are in decline? Suppose the new industries absorb less labour than is discarded by the old declining industries? After all, if the effect of technology is to allow call centres to create jobs in India at the expense of the USA or the UK, does this not harm employment in those countries?
The counter-argument to this lies in the notion of the gains from specialisation. This argues that countries can gain from international trade through specialising in certain activities. Setting up call centres in India frees UK workers to work in sectors in which the UK can specialise efficiently.
There is one proviso, of course. It is important that the workers released from the declining sectors have (or can obtain) the skills that are needed for them to be absorbed into the expanding sectors. This recalls the question of whether the labour market is sufficiently flexible to adapt to changes in the pattern of economic activity.
How is contracts and legislation a policy to improve the flexibility of the labour market?
An impediment to flexibility in the labour market arises from the nature of employment contracts between employer and employees, which often specify conditions under which a worker can be released from employment. For example, contracts may specify the period of notice that a firm must give before terminating employment. This is reinforced by legislation that sets out redundancy conditions, so that firms wanting to cut jobs need to recompense workers. This may limit the ease with which firms can reduce employment in the short run, and increases the cost of doing so. This may explain why firms might not reduce their workforce when a recession affects the economy.
One way in which firms have tried to gain more flexibility in hiring and firing is through the use of part-time workers and zero-hours contracts. Part-time workers have less negotiating power with employers. Zero-hours contracts give employers even more flexibility, as employees on such contracts have no guaranteed hours at all, so actual hours worked may vary from week to week. Such contracts are naturally unpopular with workers, and there has been discussion about the extent to which they should be permitted.
