Labour Market Equilibrium

Laura Salisbury

ECON 3240: Labour Economics

Fall 2013

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Competitive Markets

Product market and labour market perfectly competitive

Firms:
Firm small relative to size of both markets
Firm a price-taker in both product and labour markets
Workers:
Each worker is small relative to size of both markets
Workers are price-takers in product and labour markets
Equilibrium wage: labour demanded = labour supplied.

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Individual Firm

Individual firm demands certain amount of labour at any wage:

Short run: firm demands quantity of labour at which MRPN = W .
Long run: labour demanded depends on substitutability with capital,
etc.
Labour market comprised of individual firms.

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Market Demand for Labour

Market labour demand curve: horizontal sum of individual firms

labour demand curves
Example:
Suppose market consists of 2 firms
When w = 2, firm 1 demands 2 units of labour and firm 2 demands 3
units of labour
Market demand for labour when w = 2 is 5 units of labour.

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Market Labour Demand Curve

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Market Labour Demand Curve

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Market Supply of Labour

Each individual worker has a labour supply curve.

Market labour supply curve is horizontal sum of individual supply
curves.
Example:
Suppose market consists of two workers.
When w = 2, worker 1 is willing to supply 10 units of labour and
worker 2 is willing to supply 5 units of labour.
Market supply of labour when w = 2 is 15 units.

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Labour Supply Curve Faced by Individual Firm

Perfect competition: firms face perfectly elastic (horizontal) labour

supply curve
Firm is so small relative to market, it can hire as much or as little
labour as wants to at the market wage (in the long run).
Short run:
Firm might have to increase wages to attract more labour
Dynamic Monopsony
Long run:
If firm raises wages above market wage to attract more labour, it will
experience an influx of workers, which will drive wage wage to market
wage.

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Labour Supply Curve Faced by Individual Firm

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Working with Supply and Demand

Market equilibrium: wage at which labour demanded (N D ) equals

labour supplied (N S ).
Why?
Suppose that, at the going wage w , N S > N D .
There are more people willing to work than jobs available.
Some workers will offer to work for less w .
Market wage will fall.

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Working with Supply and Demand

Suppose that, at w , N D > N S .

There are more job openings than workers
Some firms will offer to pay more than w to attract workers
Market wage will rise
In equilibrium, everyone willing to work at w is working, and every
firm willing to hire workers at w is hiring workers.

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Working with Supply and Demand

Calculating equilibrium wages and employment

Linear supply and demand functions:
Demand: N D = a + bW
Supply: N S = c + dW
In equilibrium, N D = N S
a + bW = c + dW
ac
W = db

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Linear Supply and Demand

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Working with Supply and Demand

Example:
N D = 25 3W
N S = 5 + 2W
What is equilibrium wage and employment?
Set 25 3W = 5 + 2W
W = 4 and N = 13

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Working with Supply and Demand

Benefit from working with supply and demand function: evaluate

effect of public policies on wages and employment.
Demand curve:
Relationship between wage paid by employers and labour demanded
Supply curve:
Relationship between wage received by workers and labour supplied
Payroll taxes or subsidies alter relationship between wages and
amount paid/received for a unit of labour.

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Payroll Taxes and Subsidies

Example: payroll tax paid by employers

Increases cost of hiring a unit of labour.
Shifts demand curve down.
Example: wage subsidy given to workers
Increases effective wage workers receive for every unit of labour
supplied.
Shifts supply curve up

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Incidence of Unit Payroll Tax

Example: how does a unit payroll tax affect equilibrium wages?

Unit payroll tax:
Employers must pay a tax T to the government for every unit of labour
hired.
Expect this to lower the wages firms are willing to pay for every unit
of labour.
Shift labour demand curve downward.
How much will this change equilibrium wages?

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Incidence of Unit Payroll Tax

Example: Add unit payroll tax of T to previous example:

Labour demand before tax: N D = 25 3W
Labour supply: N S = 5 + 2W
A payroll tax of T increases wages that firms have to pay by T per
unit.
New labour demand: N D = 25 3(W + T ).
Then, equilibrium wages are:
W1 = 4 53 T
Recall: wage without payroll tax was W0 = 4
Then, wage under payroll tax is: W1 = W0 53 T
Wage falls by fraction of payroll tax.

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Incidence of Unit Payroll Tax

3
Decline in equilibrium wages caused by payroll tax: 5T.
Less than T
Incidence of tax: What fraction of tax is paid by employers? What
fraction is paid by workers?
Workers:
Before tax: workers received W0 = 4
After tax: workers receive W1 = W0 35 T
Amount workers receive falls by 35 T .
Employers:
Before tax: employers paid W0 = 4
After tax: employers pay W1 + T = W0 35 T + T = W0 + 52 T
Amount employers pay increases by 25 T
Workers pay 3/5 of the tax, employers pay 2/5 of the tax

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Incidence of Unit Payroll Tax

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Incidence of Unit Payroll Tax

Example:
Labour demand: N D = 20 2W
Labour supply: N S = 8 + W
Payroll tax of $3 per unit of labour hired.
What are wages without the payroll tax? What are wages with the
payroll tax? How much do equilibrium taxes fall as a result of the
payroll tax? What is the incidence of the tax?

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Taxes and Subsidies: Main Points

Taxes and subsidies in competitive markets: main points

Payroll taxes and subsidies shift labour demand or labour supply curve,
depending on who tax/subsidy applies to
Taxes and subsidies will be effectively paid by both sides of the market
Way in which tax/subsidy is shared between demand and supply side
depends on relative elasticity of demand and supply
In general, less elastic side of the market pays more of the tax.

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Monopsony in the Labour Market

Monopsony: Single employer in labour market

Analogous to monopoly in product market
Firm chooses the wage it pays its workers.
Firm in competitive labour market faces horizontal labour supply
curve:
Firm can hire as much or as little labour as it wants to at going wage;
its decisions will not change the wage.
Monopsonist faces upward-sloping labour supply curve:
If firm wants to hire more workers, it has to increase wages

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Monopsony in the Labour Market

Implication: marginal cost of labour is greater than the wage.

Why?
If a firm wants to hire more labour, it must increase the wage
This means it is paying higher wages to all of its workers.
Example:
Suppose firm employs one worker for a wage of $1 per hour.
To hire an additional worker, firm must pay wage of $1.20 per hour.
What is marginal cost of second worker?
Cost of hiring one worker for one hour = $1
Cost of hiring two workers for one hour = $1.20 + $1.20 = $2.40
MC of second worker = $2.40 $1.00 = $1.40 > $1.20

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Monopsony in the Labour Market

Implications:
Just like competitive firm, monopsonist will choose wage at which
marginal revenue product of labour equals marginal cost of labour.
This optimal wage will be lower than equilibrium wage in competitive
labour market.
Monopsony will hire fewer workers than competitive labour market.
See graph for proof

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Monopsony in the Labour Market

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Monospony in the Labour Market

What do monopsonies look like in real life?

Industry towns
e.g. Coal mines in isolated region
Employers of people with specialized skills
e.g. the NFL
Walmart?
Often have unions to combat market power of monopsonists.

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Minimum Wages

Minimum wage:
Price floor for labour
Illegal to pay workers less than minimum wage
Varies by province
Highest: Nunavut ($11 per hour)
Lowest: Alberta ($9.95 per hour)
Some workers under federal jurisdiction

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Evolution of Minimum Wages

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Why Minimum Wage?

Why have a minimum wage?

Poverty reduction
Prevent low-wage competition
Criticisms:
Increases unemployment among low-wage workers
This lecture: we will discuss consequences of minimum wage
legislation.

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Effects of Minimum Wage - Perfect Competition

Minimum wage below equilibrium wage:

Non-binding
No effect on wages or employment
Minimum wage above equilibrium wage:
Binding
Labour supplied > labour demanded
Creates unemployment: N S N D

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Effects of Minimum Wage - Perfect Competition

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Effects of Minimum Wage - Perfect Competition

Define:
Nc = labour demanded/supplied without minimum wage
Nm = labour demanded under minimum wage
Ns = labour supplied under minimum wage
Unemployment under minimum wage = Ns Nm
BUT: decrease in employment only Nc Nm .
Minimum wage decreases labour demanded but also increases labour
supplied
Size of employment reduction depends on elasticity of labour demand.

Inelastic demand for labour smaller employment effect from min

wage.

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Effects of Minimum Wage - Monopsony

What if labour market is not competitive?

Monopsony single employer in labour market.
Recall: for a monopsony, MC of labour > wage.
To hire additional workers, firm must raise wages.
Cost of additional worker = wage plus wage increase to existing
workers

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Effects of Minimum Wage - Monopsony

Minimum wage can remove this issue:

Suppose minimum wage is Wm , and firm is employing N0 workers.
Now, suppose these N workers are willing to work for less than Wm
(i.e. labour supply curve is below minimum wage).
If firm wants to hire more workers, it will not have to raise wages above
Wm , because these workers are already willing to work for less than
Wm .
In this case, marginal cost of labour is equal to Wm .
Depending on choice of Wm , it is possible for minimum wage to
increase labour hired by monopsonist.
Why? See graph.

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Effects of Minimum Wage - Monopsony

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Effects of Minimum Wage - Monopsony

Intuition:
Because the firm often doesnt have to raise wages in order to attract
more labour when it is paying minimum wage, increasing employment
is less costly at the margin when there is a minimum wage.
If increasing employment is less costly, firm is more likely to do it.
Note: for minimum wage to increase employment, it must be between
W0 and VMP0

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Worked Example Minimum Wages and Monopsony

Hypothetical Example of Monopsonist Responding to Minimum Wage

No Minimum Wage Minimum Wage = 2

Units of N Wages MCN Wages MCN MRP

1 1.00 1.00 2.00 2.00 3.00

2 1.20 1.40 2.00 2.00 2.50
3 1.40 1.80 2.00 2.00 2.30
4 1.60 2.20 2.00 2.00 2.20
5 1.80 2.60 2.00 2.00 2.00
6 2.00 3.00 2.00 2.00 1.80
7 2.20 3.40 2.20 3.40 1.60

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Empirical Evidence

Do minimum wages actually reduce employment?

Difficult to assess empirically:
Many other factors change at same time as minimum wage legislation
Differences between provinces other than legal minimum wage
Make use of changes in minimum wage law over time.
Often focus on teen employment - most likely to earn minimum wage.

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Empirical Evidence

In general, empirical evidence on effects of minimum wages is mixed.

US studies:
1980s declining minimum wage.
No evidence of increasing employment
1990s increasing minimum wage.
Little to no evidence of decreasing employment
Canadian studies find modest disemployment effects from minimum
wage

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Application: Fast Food Workers

Card & Krueger (1994)

New Jersey increased state minimum wage from $4.25 to $5.05 per
hour in 1992.
How did this affect employment in New Jersey?
Challenges:
Identifying group likely to be affected by minimum wage increase
Ensuring that change in employment does not just reflect underlying
time trend.

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Application: Fast Food Workers

Sample of fast food restaurants

Control group: fast food restaurants in Pennsylvania
Neighbouring state
Economies closely linked
Conducted survey of establishments before and after minimum wage
increase implemented.
410 restaurants surveyed.
Approach: differences in differences

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Application: Fast Food Workers

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Application: Fast Food Workers

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Application: Fast Food Workers

Findings:
No employment reduction from minimum wage increase.
If anything, employment increased.
Why?
Corresponding reduction in non-wage benefits?
No effect on free meals to employees
Wage increase passed on to consumers through increased price of fast
food?
Mixed evidence

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Application: Fast Food Workers

Interpretation?
Difficult to explain findings with standard competitive model of
labour market.
Monopsony?
Fast food restaurants are not sole employers in labour market
Possible that they are supply-constrained, although authors do not
find much evidence that this matter.

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