Micro - The Labour Market

Question 1

Define: Marginal physical product of labour, Marginal revenue product of labour, Derived Demand, Wage Elasticity of Demand

Answer 1

Marginal physical product of labour (mrpl) - The addition to firms’s total output brought about by employing one more worker, measures amount by which a firms total output rises in short run.

Marginal revenue product of labour - The money value of the addition to a firm’s total output by employing one more worker.

Derived Demand - The demand for one good/ service that is a consequence of the demand for something else.

Wage Elasticity of Demand - The responsiveness of demand (for labour) to a change in wages

Question 2

Labour as a derived demand

Answer 2

A firm demands more labour when profits can rise by employing more workers, this occurs when the demand for goods and services rises meaning firms will need to increase output to reach the excess demand.
e.g in recession demand for goods and services fall causing demand for labour to fall creating cyclical unemployment.

This is similar to other facts of production

Factors affecting labour as a derived demand:
Employment tax, labour productivity

Question 3

Marginal Productivity Theory

Answer 3

Marginal physical product of labour (mrpl) - The addition to firms’s total output brought about by employing one more worker, measures amount by which a firms total output rises in short run.

Marginal revenue product of labour - The money value of the addition to a firm’s total output by employing one more worker.

The amount to which a firm’s total output and revenue rises in the short run as a result of employing one more worker.

Marginal physical product (MPP) x marginal revenue(MR) = Marginal revenue product of labour (MRPL)

In perfect competition MRPL = MPP x price

MRP tells a firm at a given wage rate how many employees it should employ, if worker mrp = to wage they will get the job.

Criticisms of MRP:
1.Measuring labour efficiency / productivity can be difficult, for example in teaching the output that teachers provide is not marketed so to work out mrp for teachers is hard, means schools cannot determine number of workers to employ at a given wage rate

2. Collaborative work makes it difficult to establish the productivity of individual workers, many products are the result of inputs drawn from different countries – each contributing to value added (e.g. the iPhone)
3. Many people have the ability to set their own pay e.g. the self-employed and directors of businesses, self-employed won’t set there wage rate at MRP going against the theory of workers wage being =/more than the wage they would get the job.
4. As always we assume we assume this is done in perfectly competitive market

Question 4

The Labour Demand Curve

Answer 4

The demand for labour shows how many workers an employer is willing and able to hire at a given wage rate in a given time period

There is an inverse relationship between demand for labour & the wage rate
If the wage rate is high more costly to hire extra employees causing less employment
When wages are lower, labour becomes relatively cheaper than capital. A fall in the wage rate might create a substitution effect and lead to an expansion in labour demand as it could become more cost effective to use labour than capital as a factor of production.

Question 5

The causes of shifts in the demand curve for labour.

Answer 5

The labour demand curve shifts when there is a change in conditions for demand in labour market (other than wage rate):

PDPC

Price - Change in final price of the product labour is making, MRPL = MPPL x marginal revenue, so if price change MR changes. e.g if price increases in ceteris paribus MRP of the worker will rise causing demand curve to shift right

Demand - Change in demand for the final product labour makes, if demand for good increases labour is derived demand so will increase with it to meet excess demand (occurs if cyclical recovery after recession)

Productivity - Change in labour productivity affects marginal product of labour, when productivity increases subsequent increase in MRP

Capital - Change in cost of capital, labour and capital are substitutional, if cost of capital rises then the demand for labour will decrease as capital becomes the more cost effective factor of production

Technological change (links to productivity and capital) - technological progress can make labour more productive when compared to capital as it will reduce the marginal cost for each product leading to lower prices making demand for the good as lower prices can be passed onto consumers. Technological progress can have opposite effect where it becomes a substitute for labour increasing productivity for capital relative to labour causing demand for labour to decrease causing structural unemployment as workers skills are replaced by capital (technological unemployment). 
Always relate shifts to MRPL to explain why demand shifts

Question 6

Elasticity of Demand for Labour

Answer 6

Elasticity of labour demand measures the responsiveness of demand when there is a change in the wage rate. Depends upon:

SECT

1. Substitutability of capital for labour - Labour demand is more elastic when a firm can substitute easily and cheaply between labour & capital inputs. e.g if wage rates rise firms can replace workers with capital at lower costs the proportional decrease in labour demand will be much greater than the increase in wage if capital is substitutional
2. Price elasticity of demand for the final product - This determines whether a firm can pass on higher labour costs to consumers in higher prices. If demand is inelastic, if wages increase firms will not sack workers instead they will pass on increased costs to consumers via higher prices as the demand for the good/service will remain the same. more price inelastic the final product the more wage inelastic labour demand is.
3. Costs of labour as a % of total cost - When labour expenses are a high % of total costs, then labour demand is more wage elastic. The greater labour costs as a % of total costs the more wage elastic labour demand is.
4. Time period - In the long run it is easier for firms to switch factor inputs e.g. bring more capital in perhaps replacing labour meaning over long periods of time demand for labour will be more elastic, in short run labour demand more inelastic

Question 7

Labour Supply curve

Answer 7

The labour supply is the number of hours people are willing and able to supply at a given wage

As wages rise other workers join the industry attracted by the incentive of higher rewards, the extent to which a rise in wage or salary lead to an expansion in supply of labour depends on elasticity of labour supply in that occupation.

Question 8

Relationship between Wage rates and Supply of labour

Answer 8

Substitution effect: An increase in wages also increases the opportunity cost of leisure time so now leisure is more costly so workers will substitute from leisure to work, this increases the supply of labour

Real Income effect: An increase in wage also increases incomes meaning people are increasingly able to consume leisure. Higher incomes also mean you don’t need to work as much to maintain income and can enjoy more leisure.

For a worker to maximise personal welfare, their private benefit received by a worker from supplying labour equals the marginal private cost incurred by giving up leisure time (real income effect)

However at higher wage rate, incentive increased this means to maximise personal welfare the worker would be expected to supply more labour but losing out on leisure time.

Question 9

Monetary and non-monetary considerations in supply of labour and how they shift labour curve

Answer 9

Monetary Considerations:
Wages in substitute occupations - wage rates in relation to other/similar occupations will determine supply of labour, e.g if a substitute labour market has an increase in relative wage compared to one industry then workers will switch jobs to receive better monetary benefits (s1 shift left as total supply of labour decreases).

Barriers to entry - Artificial limits to an industry’s labour, e.g minimum requirements in form of degrees or experience, restricts supply while increasing wage rate i.e accountants need financial degree to join the accountant labour force (does not shift supply curve unless restrictions increase/decrease or restrictions become harder/easier to receive e.g doctors have high restrictions over time restrictions have increased so over time s1 has shifted left to s2).

Mobility of labour - How easily workers can move to different jobs in the economy, e.g if there are wide array of apprenticeships or training schemes easily for workers to switch jobs

Non-Monetary Considerations:
Risk - safety risk of job (if unsafe then supply of labour will be lowered)
Holidays - some jobs may receive more opportunities to have breaks e.g teachers

Job satisfaction - does it degrade/boost mental health, e.g individuals may look to work in retail sector as they enjoy the social aspect of the job
Job security

Work conditions - if the job is associated with health problems supply of labour industry may be low

Other factors in the supply of labour:

Net migration of labour - Net inward migration boosts the active labour supply in many occupations such as skilled professions like doctors in the NHS

Question 10

Elasticity of Labour Supply

Answer 10

Measures the responsiveness of labour supplied given a change in the wage rate.

1. Artificial limitations to joining labour supply - Longer the training period is the less likely workers will be able to join the labour force in the industry if wages rise e.g if doctor wages increased by 25% the supply of doctors would remain similar in short run as workers won’t be able to switch their profession if they do not have correct qualification, wage elasticity for unskilled labour is higher than skilled

Supply of labour is likely to be elastic in long run while being inelastic in the short run

2. Vocation - In jobs that include larger vocations or time for leisure are likely to be less impacted by a decrease in wage, e.g teachers have more vocations than the normal as their job relates to the school year this is an added bonus of taking on the job reducing the likelihood of supply of teachers falling heavily if wages fell.

Question 11

Define: Homogeneous Labour, Wage Differentials, Market Forces, Wage takers, Perfectly substitutable labour

Answer 11

Homogeneous Labour: The idea that labour is exactly the same (perfectly interchangeable/substitutable). All workers have identical skills and abilities, and can transfer between jobs easily

Wage Differentials: The wage rates for different jobs are different.

Market Forces: The wage is determined by the supply of labour and demand for labour only (no Government intervention).

Wage takers: The market is so competitive that the worker has to accept the prevailing market wage.

Perfectly substitutable labour: Labour can be moved between competing uses (different industries) and maintain a proportional rate of productivity. The opportunity cost of production between competing uses is constant.

Question 12

Perfectly Competitive Labour Market Characteristics

Answer 12

There are many workers and many hirers of workers

All workers have the same skills – homogenous

Workers, employers and the firms are wage takers – can’t influence the wage rate: MC and AC for a firm are equal to the wage

There are no barriers to entry into the profession (training, skills development and qualifications). There are no barriers to exit from a profession. Movement in and out of the labour market is costless

There is perfect knowledge of market conditions for workers and employers

Firms are profit maximisers: MC of labour = marginal revenue product of the workers, MRPL – demand for labour

Used as benchmark to compare real life markets to, to explain why wage differentials happen

Question 13

Wage Determination in perfectly Competitive labour market

Answer 13

Done on Paper Flashcard

Question 14

Role of Market forces in determining relative wage rates

Answer 14

Law of one price - states in perfectly competitive market that workers with the same skills and productivity should be paid the same wage rates.

Although in real world this does not happen as most conditions for perfectly competitive market are not met

Question 15

Wage Differentials and the imperfections that cause this

Answer 15

Occupational immobility of labour - when workers are unwilling or unable to move from one job to another, occurs when workers are prevented by either natural or artificial barriers to entry, workers are not homogenous so difference in natural ability can restrict movement between jobs, artificial barriers like qualifications imposed by professional bodies and trade unions. This is not assumed in perfectly competitive markets where an individual can switch jobs freely for example when an alternate job has higher wages imposed like train drivers has lower wages compared to lawyers workers would be able to switch jobs easily however in reality this not the case.

Geographical immobility of labour - when workers are unwilling or unable to move from one area to another in search of work, occurs when financial costs of travel prevent workers from filling job vacancy e.g in UK low-paid workers in north find difficulties in filling southern jobs as little affordable housing available.

Employers can exert monopsony power if they are the only buyer of the labour causing wages to be lower therefore supply may fall as well e.g doctors or teachers employed by UK gov

Discrimination - Various forms. racial, religious or age can affect both demand and supply of labour, demand employers may be unwilling to employ certain types of labour, supply workers may refuse to work with people they discriminate against

Basically anything that goes against perfectly competitive market characteristics

Question 16

Define: Monopsony, Monopsony power

Answer 16

Monopsony - Where there is only one buyer of labour in a market

Monopsony have the following characteristics:
Buying power over their potential employees, this gives them wage-setting power as workers cannot choose alternate employers as there is only one employer in the market, creates welfare loss causing market failure

Due to this firms can exercise monopsony power by setting wages below the equilibrium point when hiring workers, for example in Uk government has extreme monopsony power although existence of private school shows government does not have pure monopsony

Monopsony Power - The market power exercised in a market by the buyer of a good or service

Question 17

Define: Trade union, collective bargaining, closed shop, industrial action, the role of trade unions

Answer 17

Trade union - a group of workers who join together to maintain and improve their conditions of employment including pay

Collective bargaining - process by which wage rates and other conditions of work are negotiated and agreed upon by a union or unions with an employer/employers

Trade union density - % of workforce that are members of a particular trade union

Closed shop - Situation were a workforce must be part of a given union (illegal in UK)

Industrial action - any action taken by union members against their employers in order to increase pressure during negotiations e.g a strike where union members refuse to work.

Key roles for trade unions

1. Protecting and improving the real living standards / real wages of their members
2. Protecting workers against unfair dismissal (i.e. upholding employment rights)
3. Promoting improvements in working conditions, work-life balance & related health and safety issues
4. Promoting better workplace training and education, i.e. the accumulation of human capital
5. Protection of pension rights for union members

Question 18

Competitive Labour Market - Trade Unions

Answer 18

Trade unions use collective bargaining to increase the power they control in the market, an individual has less power than a collective when negotiating higher wages, larger the trade union density the more power the union has.
We assume ‘closed shop’ trade unions were they have a monopoly for the supply of labour whereby all workers in a given profession are part of the same trade union, therefore they have huge amounts of power.

Now refer to the diagram:
Trade unions believe that the competitive wage rate is too low found at the competitive equilibrium for workers in the industry, they then fight for wages above Wc at Wtu, wage rate up until supply is perfectly elastic causing it to be horizontal as workers are willing and able to work at the Wtu rate however if the industry demanded more workers then they would have to increase the supply rate causing it to become upwards sloping, this creates the trade union supply curve Stu.
Due to ‘closed shop’ trade unions have great power so the new wage rate Wtu holds ( this is due to increased pressure caused as the whole labour force could take industrial action e.g strike).
Wages have increased from competitive wage rate (Wc) to a higher wage rate, the trade union wage (Wtu) shown in diagram.

However in a competitive wage rate due to the increase in the wage rate the demand for labour at the given rate of Wtu, has contracted from Qc to Qtu giving a lowered level of employment when compared to the competitive market outcome. Unemployment occurs as the supply curve shows that more workers are willing and able to work (where Wtu meets supply) however there is not enough demand for labour for them to be employed creating excess supply and subsequent unemployment, in the industry as shown in the diagram.

We can also see that there is a loss of wage income as quantity demanded falls.

For workers up until Qtu in the industry the trade union has increased their personal outcome due to the new wage rates, however workers between Qtu and Qc are left worse off as they are unemployed, even workers found at q3 that are willing and able to work cannot find a job and are equally unemployed. Therefore the introduction of a trade union distorts efficient labour market outcomes causing a significant amount of people to lose out creating inefficiency.

Firms costs of production increase which may result in bankruptcy or long run problems for workers e.g in long run firms may decrease worker conditions such as dental plans.

Question 19

Trade Union Evaluation:

Answer 19

Elasticity for demand of labour - if demand for labour is relatively wage inelastic then the extent to which unemployment occurs as a result of trade unions will be smaller in a perfectly competitive market

The market trade union power is exerted in - In perfectly competitive markets wage increase while employment falls but in a monopsony trade unions actually increase wage and increase employment, however monopsonies do not always pay below Wc as they understand the link between wage rate and productivity

Strength of Trade union - Trade union power is determined by trade union density, we assume closed shop trade union where the trade union has compete monopoly over supply of labour (100% trade union density), however in reality these are illegal meaing tu density won’t be as high as assumed meaning wage increase may not be as high

Success determined by union mark up - union mark up is the difference in wage between what workers are getting who are part of a trade union in a given market compared to the wage workers are receiving in a similar profession not in a trade union (difference between Wtu and Wc)

Real world evidence in the UK:

Legislation - since 1970 harsher legislation has been imposed,

1. closed shop trade unions have become illegal limiting trade union density and subsequent power as workers can only join trade unions against one employer not many.
2. harsher restriction on industrial action, strikes can only happen when there is at least 75% of members in the trade union for a strike (illegal to do otherwise)
3. If workers participating in a strike against a certain employer, a person employed by another worker cannot join the strike (illegal) limiting power of the strike.
4. As a result of harsher legislation from the 1970 has caused trade union membership to decline over time reducing the power of real world trade unions and subsequently how much they can distort market outcomes.

Globalisation - due to the world economy being integrated, firms can choose to reject trade union demand like an increase in wages as their is greater competitive pressures meaning if wages were to rise they would become bankrupt or lose out on market share due to foreign firms

Question 20

Imperfectly competitive market Monopsony - Trade unions

Answer 20

Assertion that unions raise wages at the expense of jobs is heavily dependant on the assumption that before, the union was formed, the labour market was perfectly competitive, in reality no labour market can meet all conditions for perfect competition therefore in the case for monopsonist labour markets both wage and employment can increase

When trade union implemented into monopsonist market, monopsony becomes a wage taker (the extent to which is stated in evaluation slide).

In monopsonist labour market:

1. introduction of trade union is similar to a perfect competition labour market where wtu is set above the competitive equilibrium point. This causes the labour supply curve to become kinked as shown in the diagram where the new supply curve is stu which equals acl.
2. But in monopsony marginal cost curve is different from the acl curve this is because to profit maximise the firm employs where mcl = mrp, this causes a double kinked mcl curve to form, as shown in diagram mcltu.
3. Provided monopsony employs smaller than or equal labour force to qtu, the mcl of employing an extra worker equals both acl and the union determined wage wtu, but beyond qtu the monopsony must offer higher wages to persuade members of the labour force to supply labour, therefore when the monopsony increases wage to obtain more supply of labour they must increase the wages for everyone causing the mcl curve to revert back to its originals causing a vertical spike whereby the mcl of employing one extra worker is shown after the vertical spike.
4. When union sets new wage of wtu employment is shown to rise qm to qtu where the mrp curve intersects the mcl curve, therefore increasing both wage rates and employment, both wages and quantity of workers employed are closer to the competitive equilibrium. This is because firms in this market will still look to maximise profits causing them to demand labour where mrp=mcl
5. Benefit of trade union is shown in how much monopsony power decreases as shown in the diagram whereby monopsony power is the difference between wages and mrp
6. evaluation points for monopsony stated in prior slide