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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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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?
Figure 12.1 Minimum-wage legislation in a competitive labour market
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.
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.
Figure 12.2 Minimum wage and a monopsonist’s marginal factor cost
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.
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’.
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.
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.
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.
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.
Figure 12.4 A wage floor in the two-sector model of the labour market
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.
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.
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.
Figure 12.5 Wage floors and search unemployment in a two-sector model
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.
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.
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.
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.
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.
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.
Income Maintenance • What institution is best for transferring income to the poorer members of society? • Efficient transfer mechanism • Topping-up mechanism • Negative income tax
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.
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.
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.
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.
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.
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.
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
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*.
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).
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.
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.
