Term 2 Week 2: The Labour Market Flashcards
What do firms consider when setting wages (2,1)
Firms set wages sufficiently high to:
-make job loss costly
-To motivate employees to work hard
-They also decide how many people to hire, with a profit maximising goal
What is a reservation wage and efficiency wage setting (1,2)
-A reservation wage is what an employee gets either from benefits or alternative employments
-Efficiency wage setting is the incentive for employers to pay above the market clearing wage
-This is to increase productivity and reduce costs associated with turnover (less turnover) and to not have to offer higher wages where the probability of the worker getting another job rises
What is the wage setting curve, and the nominal/real equations (1,2,1,1)
-The Wage setting curve represents the real wage necessary at each level of employment to provide workers with incentives to work well
-Nominal curve:
:W = P^E X B(N,Zw)
-Real curve:
w^WS = W/P^E^ = B(N,Zw)
-P^e = expected price level, zw = wage push variables (institutional, policy, minimum wages, shock variables etc), B is a positive function of employment level N
-The curve is upwards sloping, as at high wage rates more workers have incentives to work well
Why is P^e backward looking (2)
-Firms look at the CPI last year during the wage setting round when price setting
-This years inflation will depend on this years price setting, and they’ll look at this next year when wage setting (they wage set based on expected prices)
How to draw the wage setting curve (4)
-It is an upwards sloping curve
-x axis = employment rate, y axis = real wage
-It doesn’t start from the x axis, the gap being the unemployment benefit + disutility of labour (mental and physical cost of labour)
-The WS curve will continue until it stops at the labour supply (vertical line at max employment), with the gap between the curve and this at any real wage point being unemployment
What shifts the WS curve (3)
-Changes in the level of unemployment benefits
-Changes in the disutility of work (changing working conditions)
-Changes in union strength
What is the price setting curve, and the price setting equation (1,2)
-The Price-Setting curve represents the real wage paid when firms choose their profit maximising price
The equation is:
-P = (1 + μ)MC, Where μ is the mark up for profit
-P = (1 + μ)(W/MPL), where λ is productivity
How can we rearrange the price setting equation if we assume constant productivity (λ) and mark up (µ) are constant (5)
-P = (1 + μ)W/λ
-W/P = (1/(1+µ))λ
-Since µ is very small, we can estimate (1/1+µ) as(1-µ)
-W/P = (1-µ)λ = λF(µ, zp), where zp is the tax wedge
-λ = W/P + λµ (output per worker = real wage per worker + real profit per worker)
How to draw the PS curve (2,1)
-Employment on the x axis, real wage on the y axis (W/P)
-The price setting curve is a horizontal line, as is the average product of labour (λ)
-λ is the difference between the APL curve and 0, W/P is the difference between price setting and 0, λµ is the distance between the APL and PS curve (firms profit as real profit per worker)
What causes shifts in the PS curve (3)
-A change in the mark up (µ), due to changes in competition determining how much higher than costs firms can reasonably price w/o losing market share
-A change in productivity (λ), as the greater the level of labour productivity, the higher the real wage that is consistent with a given mark up (both APL and PS shift)
-A change in the tax wedge (zp), as the difference between real consumption wage and real product wage is the tax wedge. W = W/Pc is the real consumption wage, where W is the money post tax, and Pc is the CPI (PC = P(1+tv))
Where is labour market equilibrium, and the assumption made in this (3,1)
-The labour market is in equilibrium where the curves cross and w^WS = w^PS
-B(N, zw) = λf(µ, zp)
-This defines the unique equilibrium level of employment, the associated equilibrium rate of unemployment
-However, this is made under the assumption that average prices and prices expected are expected to prevail (WS curve is based on Pe, PS curve is based on P)
How could we change the equilibrium unemployment (3,1)
-The equilibrium unemployment rate is the outcome of structural/supply side features which lie behind the WS and PS curve
-It can therefore be changed by supply side policies and structural changes
-Any government policy affecting WS or PS outcomes will shift it, especially ones relating to the cost of job loss
-The government can also use demand side policies to return to equilibrium if there is an output gap
What do trade unions do (3)
-Trade unions negotiate with employers in the interest of workers over issues
-Trade unions can play a big role in how the labour market works, as wages are determined through a process of negotiation
-However, trade unions cannot determine how many people the firm hires
Why is involuntary unemployment at equilibrium unavoidable (2)
-Employers and workers have a conflict of interest over how hard employees work
-Employers can’t specify the quality/quantity of work effort they’ll recieve
