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Chapter Fifteen

Wage and Employment Determination Under Collective Bargaining. Chapter Fifteen. Modeified from slides c reated by: Erica Morrill. Chapter Focus. Union behaviour Interaction between firms and unions Inefficient production decisions Inefficient union practices Bargaining power.

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Chapter Fifteen

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  1. Wage and Employment Determination Under Collective Bargaining Chapter Fifteen Modeified from slides created by: Erica Morrill

  2. Chapter Focus • Union behaviour • Interaction between firms and unions • Inefficient production decisions • Inefficient union practices • Bargaining power

  3. Theory of Union Behaviour • Unions attempt to maximize objectives given economic constraints • Ability to characterize preferences of unions is difficult

  4. Union Objectives • Utility is a positive function of wage rate (W) and employment (E): u(W,E) • Indifference curve is downward sloping • higher wage is needed to compensate for lower employment • Curves have a convex shape • diminishing marginal rate of substitution

  5. U2 U1 U0 a1 a3 a0 a2 DL Figure 15.1Union Objectives and Constraints Real Wage Rate W P Wa P Employment E

  6. Special Cases of Objective Functions • Maximize the Wage rate • indifference curves are horizontal straight lines • Maximize Employment • indifference curves are vertical straight lines • Maximize the (real) wage bill • Indifference curve is downward sloping and convex to the origin (disregards alternative wage rate) • Maximize economic rent • curve out from the intersection of alternative wage • Maximize total union utility: Lu(w)+(N-L)u(Wa).

  7. Additional Considerations • Deriving union objectives is simplest when: • preferences are homogeneous • leaders are constrained by democratic decision-making processes • union membership is exogenously determined

  8. Monopoly Union Model • Unions negotiate wages taking into account the consequences • The firm decides the employment level • maximizing profits given W set by the union, which yield the demand for labor function, DL. • DL curve is analogous to a budget constraint • Program: Max u(W,E), subject to DL curve • Equilibrium is the tangent of the iso-utility curve and DL curve

  9. Firms Iso-profit Curves • Combinations of wage and employment of equal profits, . • Higher profits on lower curves • Firm cannot pay wages below the alternative wage • Wage will lie between the alternative wage rate and the bargaining wage

  10. 0=0 W0 If Wf = Wa DL * Figure 15.4The Firm’s and Union’s Preferred Wage-Employment Outcomes W Iu Wu U* E

  11. Relaxing the Demand Constraint • Union’s attempt to alter the constraint in their favor • increasing labour demand (thus increasing E) • making demand more inelastic (thus resulting in higher W and minor job loss) • Restricting substitution possibilities • collective bargaining • influencing public policy • Influence product market • supporting quotas, tariffs and restrictions on foreign competition

  12. Efficient Wage and Employment Contracts • Negotiating over wage and employment is mutually advantageous • Pareto-efficient wage-employment outcomes • union’s indifference curve tangent to the firms iso-profit curve

  13. C A A’ A’’ B C’ DL Figure 15.5Efficient and Inefficient Wage-Employment Contracts W Wa  E

  14. Contract Curve • Locus of the Pareto-efficient wage-employment outcomes • Union cares about wages and employment • CC must lie to the right of DLcurve • Firms and unions are better off negotiating an outcome on the contract curve • Moving up on the CC makes unions better off • Moving down makes the firm better off

  15. Efficient Versus Inefficient Contracts • Monopoly union model (inefficient) • firm unilaterally sets employment • Contract curve (efficient) • negotiate over wage and employment

  16. Figure 15.6Inefficient and Efficient Contracts C W C’ DL E

  17. Theory of Bargaining • Predicting the outcome and explaining depend factors • Common features • Bargaining over a set of possible outcomes • Minimum for each party • Voluntary agreement • Neither will agree to an outcome worse than minimum

  18. U F Figure 15.7The Nash Bargaining Solution Max V=(U-U0)*(F-F0) The Nash solution A N U0 T F0 fN d

  19. Solutions to the Sequential Bargaining Problem • Rubinstein’s Theory (sequential bargaining model) • some concepts of non-cooperative game theory • bargainers take turns making offers sequentially • counter offers can be made • utility shrinks in each round (reflecting discount factors)

  20. U U2 R UR B UB f3 f2 f1 F F fR Figure 15.8The Rubinstein Solution to the Bargaining Problem Rubinstein’s Solution Effect of delay Costs U1 R UR A U0 C d U4 fB f4 fR f3 f2 f1 d Bargaining lasts for 3 rounds: u-f-u 3rd round: u offers U0 2nd round: f offers C; 1st round: u offers R Sequence: f-u-f 3rd round: f offers fB 2nd round: u offers B; 1st round: f offers A

  21. End of Chapter Fifteen

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