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Theory of Income Distribution and Wages in Perfect Competition

Explore the Theory of Income Distribution and Wages under Perfect Competition, including market dynamics, wage determination, labor mobility, and demand theories. Understand how wage rates affect labor supply and industry output.

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Theory of Income Distribution and Wages in Perfect Competition

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  1. Theory ofDistribution of Income

  2. Theory of the Distribution of Income Wages under Perfect Competition

  3. Wages under perfect competition • Perfect labour markets • assumptions • no market power, everyone is a wage taker • freedom of entry and exit • perfect knowledge • homogenous labour • market determination of wage rate

  4. A labour market: whole market Sall workers in the market Dall firms in the market Wm Hourly wage O Labour hours

  5. A labour market: individual employer Dindividual employer Firms are wage takers and thus face an infinitely elastic supply of labour. Slabour Wm Hourly wage Q1 O Labour hours

  6. A labour market: individual worker Sindividual worker Dlabour Wm Hourly wage Workers are wage takers and thus face an infinitely elastic demand for labour. Q2 O Labour hours

  7. Wages under perfect competition • The supply of labour • supply of hours by an individual worker • marginal disutility of work

  8. The marginal disutility of hours worked MDU Disutility O Hours worked

  9. Wages under perfect competition • The supply of labour • supply of hours by an individual worker • marginal disutility of work • income and substitution effects of wage changes • shape of the individual’s supply curve of labour

  10. The supply of hours worked S Hourly wage O Hours worked

  11. Backward-bending supply curve of labour S WI Above w1 the income effect of a higher wage rate is greater than the substitution effect. Hourly wage O Hours

  12. The choice of hours worked at different wage rates B1 Wage rate of £5 per hour x I1 4 £150 Assume 12 hours available to be divided between work and leisure £120 Daily income £60 £40 O 12 Daily hours of leisure

  13. The choice of hours worked at different wage rates B2 y I2 Wage rate of £10 per hour 3 £150 Higher wage rate (£10) causes the person to work one more hour. Substitution effect outweighs income effect. £120 Daily income B1 £60 x £40 I1 O 12 4 Daily hours of leisure

  14. The choice of hours worked at different wage rates B3 z I3 Wage rate of £12.50 per hour Higher wage rate (£12.50) causes the person to work less. Income effect outweighs substitution effect. This gives backward-bending supply curve of labour. £150 B2 £120 y Daily income I2 B1 £60 x £40 I1 O 12 3 4 Daily hours of leisure

  15. Wages under perfect competition • The supply of labour • supply of hours by an individual worker • marginal disutility of work • income and substitution effects of wage changes • shape of the individual’s supply curve of labour • supply of labour to an individual employer • market supply of a given type of labour

  16. Wages under perfect competition • Elasticity of supply • the mobility of labour • geographical mobility • occupational mobility • economic rent and transfer earnings

  17. Wm Qm The market for nurses S Wage rate D O Number of nurses

  18. Transfer earnings (2) The market for nurses S b Wm Wage rate Economic rent (1) a D Qm O Number of nurses

  19. Economic rent The market for Dame Edna Everage S W Dame Edna’s salary D 2 1 Number of Dame Ednas

  20. Wages under perfect competition • The demand for labour: marginal productivity theory • marginal revenue product of labour (MRPL )

  21. Marginal physical product of labour curve MPPL x Diminishing returns set in here Output O Q of labour

  22. The profit-maximising level of employment Profit maximising employment of labour. MCL= W Wm MRPL £ MRPL = MPPL× Pgood Qe O Q of labour

  23. Wages under perfect competition • The demand for labour: marginal productivity theory • marginal revenue product of labour (MRPL ) • derivation of a firm's demand curve for labour

  24. Deriving the firm’s demand curve for labour a b c MRPL £ MCL1 W1 MCL2 W2 MCL3 W3 At a wage rate of W2, Q2 workers will be demanded. Thus point b is another point on the demand curve. At a wage rate of W1, Q1 workers will be demanded. Thus point a is one point on the demand curve. Profits maximised where MRPL = MCL At a wage rate of W3, Q3 workers will be demanded. Thus point c is another point on the demand curve. O Q1 Q2 Q3 Q of labour

  25. Deriving the firm’s demand curve for labour a MCL1 W1 b MCL2 W2 c MCL3 W3 £ The MRPL curve traces out the demand curve D O Q1 Q2 Q3 Q of labour

  26. Wages under perfect competition • The demand for labour: marginal productivity theory • marginal revenue product of labour (MRPL ) • derivation of a firm's demand curve for labour • derivation of the industry demand curve for labour

  27. Using the firm’s demand curves for labour to derivethe industry demand curves for labour a £ W1 MCL1 MRP1 O Q of labour

  28. Using the firm’s demand curves for labour to derivethe industry demand curves for labour b MRP2 £ a W1 MCL1 W2 MCL2 A fall in the wage rate will increase industry output and hence push down the price. This will shift the MRP curve inwards. MRP1 O Q of labour

  29. Using the firm’s demand curves for labour to derivethe industry demand curves for labour b c MRP2 £ a W1 MCL1 W2 MCL2 The industry demand for labour is the horizontal sum of the green lines (connecting points a and c) MRP1 O Q of labour

  30. Wages under perfect competition • Elasticity of demand for labour • determinants of elasticity • price elasticity of demand for the good • ease of factor substitution • elasticity of supply of other factors • wage costs as a proportion of total costs • time period

  31. Wages under perfect competition • Wages and profits under perfect competition • MRP slopes down, thus last worker adds less to revenue than previously employed workers • if all workers are paid the MRP of the last worker , there is a surplus for the firm over its wage bill, contributing to profits

  32. Wages and profits MRPL £ Profit maximised at employment of Qe MCL = W W O Qe Q of labour

  33. Wages and profits MRPL £ Surplus for firm MCL = W W Wages O Qe Q of labour

  34. Wages under perfect competition • Equality and inequality of wages under perfect competition • equality will exist when: • workers have identical abilities • there is perfect knowledge • there is perfect mobility in long run • all jobs are equally attractive

  35. Wages under perfect competition • In practice, inequality of wages between markets will persist under perfect competition • jobs are not identical • workers’ abilities are not identical • demand and supply are constantly changing • Factors that contribute to poverty under perfect competition include • lack of skills that increase productivity • participation in labour markets with high level of supply/ low demand • working in contracting industries

  36. Theory of the Distribution of Income Wage Determination in Imperfect Markets

  37. Wages in imperfect markets • Types of factor market power • Firms with monopsony power in employing labour • MCL > W

  38. MCL ACL º W (supply curve) MRPL Monopsony £ O Q of labour

  39. Wages in imperfect markets • Types of factor market power • Firms with monopsony power in employing labour • MCL > W • effects on wages and employment

  40. Profit maximised where MCL = MRPL Perfectly competitive equilibrium Q1 Monopsony £ MCL ACL º W (supply curve) W2 W1 MRPL O Q2 Q of labour

  41. Wages in imperfect markets • Types of factor market power • Firms with monopsony power in employing labour • MCL > W • effects on wages and employment • Unions with monopoly power • employers with no market power • effects of wage increases on employment

  42. Monopoly union facing producers under perfect competition W1 £ S D O Q1 Q of labour

  43. Monopoly union facing producers under perfect competition Excess supply of labour £ S W2 W1 D O Q2 Q1 Q3 Q of labour

  44. Wages in imperfect markets • Types of factor market power • Firms with monopsony power in employing labour • MCL > W • effects on wages and employment • Unions with monopoly power • employers with no market power • effects of wage increases on employment • Bilateral monopoly • no unique equilibrium • relationship between wage rates and employment

  45. Bilateral monopoly S1 (=ACL1) MCL1 No union No union MRPL £ Monopsony: no union W1 O Q1 Q of labour

  46. Bilateral monopoly MCL1 No union MRPL £ S1 (=ACL1) x MCL2 = ACL2 W2 Bilateral monopoly No union W1 O Q3 Q1 Q of labour

  47. Bilateral monopoly MRPL £ MCL1 x MCL2 = ACL2 W2 Wage can rise to W2 with no fall in employment W1 O Q1 Q of labour

  48. Bilateral monopoly MRPL £ MCL1 x W2 MCL3 = ACL3 W3 Wage can rise from W1to W3 and employment rises to Q2 W1 O Q2 Q1 Q of labour

  49. Wages in imperfect markets • Collective bargaining

  50. UK trade union membershipas % of total employed plus unemployed % Sources: A. Marsh and B. Cox, The Trade Union Movement in the UK 1992 (Malthouse Press); Trade Union Membership (BERR)

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