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Chapter 12 Labour Market Applications

Chapter 12 Labour Market Applications. Minimum Wage Legislation. The real question regarding minimum wage legislations is, “do they help the working poor?” Does it achieve a desired redistribution of income? Are workers in the industry “better-off”?

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Chapter 12 Labour Market Applications

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  1. Chapter 12Labour Market Applications

  2. Minimum Wage Legislation • The real question regarding minimum wage legislations is, “do they help the working poor?” • Does it achieve a desired redistribution of income? • Are workers in the industry “better-off”? • Whose income falls to make up for the rise in minimum wage income? • Is inefficiency an invariable side effect?

  3. Figure 12.1 Minimum-wage legislation in a competitive labour market

  4. Minimum Wage in a Competitive Labour Market • In a competitive market, inefficiency is a necessary by-product of an effective minimum wage law. • As labour services are no longer put to their most productive uses, either unemployment or underemployment will signal that inefficiency. • Underemployed workers in Figure 12.1 are those who have a marginal product of $12 in this industry, but choose to work in a less productive industry rather than face the chance of unemployment.

  5. Monopsonistic Labour Markets • A monopsonistic labour market has a single buyer of labour. • The implications of minimum-wage legislation are very different compared to a competitive market. • Figures 12.2 and 12.3 illustrate why this is the case.

  6. Figure 12.2 Minimum wage and a monopsonist’s marginal factor cost

  7. From Figure 12.2 • Once a minimum wage is brought into a monopsony, the marginal factor cost (MFC) will change. • The monopsonist’s pre-legislation MFC is the line segment DBC. • The post-legislation MFC is now two lines, w’A and BC.

  8. From Figure 12.2 • If the monopsonist hires an amount of labour less than z’, its MFC is w’. • If it hires beyond that point, its MFC is segment BC of its original MFC function because it can hire additional workers only at a wage rate higher than w’.

  9. Figure 12.3 Minimum wage and monopsony

  10. From Figure 12.3 • Does a minimum wage increase workers’ incomes? • Yes. As long as the wage is not higher than w”’, some workers are better off and none worse off. Why? - At w* or below, it has no effect. - At above w* but below w’’’, workers hired before the introduction of the minimum wage will be paid more and new workers will be hired at the new (minimum) wage. - If the rate is w”’, no new workers are hired, but existing workers will be paid more.

  11. Minimum Wage Legislation • The attractiveness of minimum wage legislation depends upon whether labour markets are competitive or monopsonistic. • Empirical evidence suggests that labour markets covered by minimum wage laws are competitive, and the laws are problematic.

  12. Minimum Wage Legislation • Workers who remain employed are better off. It is not clear at whose expense the gain is made (we do not know who pays). • By creating unemployment and underemployment, the legislation will hurt some people it was intended to help.

  13. Union Wage Rates • Although analyzing the economic consequences of unionization objectively is not easy, we can move in that direction by adapting our minimum-wage analysis to apply to union wages rates. • In this analysis, the union wage is treated like a wage floor -setting a minimum wage paid in a unionized industry.

  14. Figure 12.4 A wage floor in the two-sector model of the labour market

  15. From Figure 12.4 • Imposing the wage floor means that some workers are reallocated from sector 1 to sector 2 and as a result, the wage rate in sector 2 falls. • Because $6 is less than the competitive wage of $9, workers are not allocated to their most productive jobs. • The wage floor yields an equilibrium with underemployment.

  16. From Figure 12.4 • Assume there are unionized and non-unionized sectors and that the unionized sector is characterized by a “shape up” (all members turn up each day and a union official picks the members who work that day). • Workers are free to seek work in either sector. The number of workers looking for jobs in the union “shape up” is z1 and those looking in the non-unionized sector is z2.

  17. From Figure 12.4 • 20 jobs at the union wage of $12 are shared by all union members. • Assuming the jobs are shared equally, the proportion of time that any union member will be employed is 20/z1 (jobs/union members). • The expected wage is the union wage ($12) times 20/z1 or 240/z1.

  18. Figure 12.5 Wage floors and search unemployment in a two-sector model

  19. From Figure 12.5 • Figure 12.5 is different from 12.4 in that the expected wage rate is plotted in quadrant I. • Notice that the expected wage relationship passes point G in quadrant I because when 20 union workers look for jobs in the “shape up” each is employed full time at the union wage of $12 per hour.

  20. From Figure 12.5 • Suppose the workers continue to join the union sector until the expected wage in the union sector equals that on the non-union sector. • Equilibrium allocation is at point C in quadrant III, with a wage of $8.

  21. From Figure 12.5 • At equilibrium point C: • 30 unionized workers are chasing 20 union jobs paying $12. • As unionized workers split available work equally, the expected wage is $240/30 = $8.

  22. From Figure 12.5 • At equilibrium point C: • 70 workers are employed in sector 2 • Unemployment equals u in quadrant I, (10 full time workers). • Note that in equilibrium in Figure 12.4 (point B in Figure 12.5), 80 non-union workers are employed in sector 2.

  23. From Figure 12.5 • It is necessary that the equilibrium wage in sector two of the underemployment model is lower than that in the unemployment model. Why? • Because in the unemployment model, some non-union workers leave sector 2 to chase jobs in sector 1. • As a result, the smaller number of non-union workers remaining in sector 2 will earn a higher wage.

  24. From Figure 12.5: • Two sources of inefficiency arise in this model: • There is unemployment equal to u in quadrant I. • The allocation of workers who are employed is inefficient because the wage floor exceeds the equilibrium wage.

  25. Income Maintenance • What institution is best for transferring income to the poorer members of society? • Efficient transfer mechanism • Topping-up mechanism • Negative income tax

  26. Figure 12.6 An efficient income-transfer mechanism

  27. The Efficient Transfer Mechanism • Although the lump-sum mechanism is efficient, it is not practical. • There is no systematic way of choosing a target indifference curve or identifying individual preferences and budgets to pinpoint recipients. • As a result, policies are formulated in terms of income-maintenance mechanisms rather than utility-maintenance mechanisms.

  28. Income-Maintenance Programs • Income-maintenance programs have the objective of raising the income of anyone below a targeted level of income, up to that level. • In practical income-maintenance schemes, the amount of the income transfer is conditional upon the amount of the recipient’s earned income.

  29. Topping Up and Welfare • The essential feature of many welfare programs is a topping-up mechanism, where the subsidy is just large enough to put the recipient at the mandated income level. • The result is that potential recipients can affect the amount of income transferred to them by choosing how much income they earn.

  30. Topping Up and Welfare • If the potential recipient earns as much or more than the targeted income level (S’), he/she will not get any subsidy. • If he/she earns an income below S’, the amount of the subsidy will be just enough to raise total income to S’. • This topping-up mechanism translates into the kinked budget line in Figure 12.7.

  31. Topping Up and Welfare • This topping-up mechanism translates into the kinked budget line in Figure 12.7, which leads to inefficiency. • The inefficiency occurs because the recipient’s MRS at E, is less than the wage rate.

  32. Figure 12.7 An inefficient income-transfer mechanism

  33. The Negative Income Tax • The negative income tax (NIT) combines the elements of the efficient lump-sum transfer and the topping-up mechanism. • Though not problem-free, this combined scheme redistributes income to poorer members of society without the gross inefficiency and the perverse lack of work incentives associated with the welfare system.

  34. Figure 12.8 A negative income tax

  35. From Figure 12.8 • This version of the NIT combines an unconditional income transfer for everyone (S’’) and a proportionate (yet moderate) income tax (t) on earned income. • Everyone receives the subsidy (S’’), pays twh in taxes, keeps (1-t)wh from his/her earned income, and receives net income equal to: x2 = S”+ (1-t)wh

  36. From Figure 12.8 • At point E in Figure 12.8, the budget line is tangent to the indifference curve and the person is indifferent between the NIT and the topping-up mechanism. • This person works h* hours and earns income equal to wh*.

  37. From Figure 12.8 • Point E is not an efficient equilibrium because the MRS is less than w. • The NIT offsets some of the inefficiencies associated with the topping-up mechanism and avoids the disincentive to work. • It also makes smaller demand on the public purse (DE for the NIT versus S’ for the topping-up mechanism).

  38. The Market for Superstars • Figure 12.9 shows two separate labour markets. There is a market demand and supply curve for talent levels of t=0.25 and the same for talent levels of t=0.35. • Consumers are willing to pay more for talented singers and we assume they can produce more CDs.

  39. Figure 12.9 Labour markets with different levels of talent

  40. The market for Superstars • A superstar market is characterized by a good or service that has a poor substitutability between quantity and quality. • Also a small number of individuals are able to supply the entire market. • More talented labour produces more CDs and gets a higher wage.

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