Competitive Labor Market Equilibrium

Competitive Labor Market Equilibrium

Dollars

Supply

w*

EDES E*

wlow

Demand

Employment

In a competitive labor market, equilibrium is attained at the point where supply equals demand.

ESED

whigh

ESE*ED

Dollars

Supply

w*

Demand

Employment

The minimum wage creates unemployment (u = U/LF).

wmin

LFE

U


• Two assumptions of the cobweb model:– Time is needed to produce skilled workers– Persons decide to become skilled workers by looking at

conditions in the labor market at the time they enter school

• A “cobweb” pattern forms around the equilibrium

• The cobweb pattern arises when people are misinformed

• The model implies naïve workers who do not form rational expectations

• Rational expectations are formed if workers correctly perceive the future and understand the economic forces at work


The Cobweb Model in the

Market for New Engineers

S

Dollars

w1

E*E2 E1

w3

w*

w2

w0

D

D

E0 Employment

The initial equilibrium wage in the engineering market is w0.Because new engineers are not produced instantaneously and because students might misforecast future opportunities in the market, a cobweb is created as the labor market adjusts to the increase in demand.

The demand for engineers shifts to D, and the wage will eventually increase to w*.

E3


Dollars

S0

w0

E1E0

D0

Employment

w1

S1

D1

w2

E2

We don’t observe all of the shifts

We observe only the first and the last equilibriums

This looks like a demand curve but it is not. It is the

equilibrium path


• It is important to note the technical meaning of efficiency

– If a change in policy can make any one better off without harming anyone else, the change is said to be “Pareto-improving”

– Corollary: If the state of the world is Pareto Efficient, then improving a person’s welfare necessarily means another’s is decreased

• The “single wage” property of a competitive equilibrium has important implications for efficiency.

– Recall that in a competitive equilibrium the w = VPL = p∙MPL

– As firms and workers move to the region that provides the best opportunities, they eliminate regional wage differentials.

– Therefore, workers of given skills have the same value of marginal product of labor in all markets.


S (workers)

D0 (firms)

w*

P

W

E*

Dollars

Employment

In equilibrium, E* workers are employed at a wage of w*. All persons who are looking for work at that wage can find a job.Triangle P gives the producer surplus,Triangle W gives the worker surplus.A competitive market maximizes the gains from trade (sum P + W)


Dollars

15.50

S

D0

14.50

135 150

The Impact of a Payroll Tax Assessed on Firms

A payroll tax of $1 assessed on employers shifts the demand curve down by $1.The payroll tax cuts the wage that workers receive from 15 to 14.50and increases the cost of hiring a worker from 15 to 15.50

Employment (millions)

D1

14

15

$1 taxTotal payroll tax

paid by employees

(135m)(0.5) = $67.5m

Total payroll tax paid by employers

(135m)(0.5) = $67.5m


A $1 payroll tax assessed on workers shifts the supply curve to the left.The payroll tax has the same impact on w* and E* regardless who it is assessed on.

15.50

S

D0

14.50

135 150

16

15

$1 tax

S1

Total payroll tax paid by employees

(135m)(0.5) = $67.5m


(135m)(0.5) = $67.5m

The Impact of a Payroll Tax Assessed on WorkersCompetitive Labor Market Equilibrium

A $1 payroll tax assessed on both firms and workers shifts the demand and supply curves to the left.

15.50 S

D0

14.50

120 150

15


(120m)(1) = $120m


(120m)(1) = $120m

S1

D1

$1 tax

$1 tax

The Impact of a Payroll Tax Assessed on Firms and WorkersCompetitive Labor Market Equilibrium

The Impact of Payroll Tax Assessed on Firms with Inelastic Labor Supply

Dollars

15

D0

S

D1

140 Employment

14

The $1 payroll tax shifts the demand curve down, lowering w to $14

A payroll tax assessed on the firm is shifted completely to workers when the labor supply curve is perfectly inelastic.


(140m)(1) = $140m


D1

Dollars

14.50

S

15.50

145130

An employment subsidy of $1 per worker hired shifts up the demand curve.The subsidy raises the wage that workers receive from 15 to only $15.50and decreases the cost of hiring a worker from 15 to 14.50

Employment (millions)

15

$1 sub

Total subsidy received by employees

(145m)(0.5) = $72.5m

Total subsidy received by employers

(145m)(0.5) = $72.5m

D0

The Impact of Employment SubsidiesCompetitive Labor Market Equilibrium

Initially, the wage in the northern region exceeds the wage in the southern region.

Southern workers want to move North, equating wages across regions at w*.

SS

Dollars

Employment

SS

DS

(b) The Southern Labor Market

Dollars

Employment

SN

DN

(a) The Northern Labor Market

SN

wN

wS

w*w*

Competitive Equilibrium in Multiple Labor Markets

P

erc

ent A

nnual W

age G

row

th

Manufacturing Wage in 1950.9 1.1 1.3 1.5 1.7 1.9

4.5

4.7

4.9

5.1

5.3

5.5

5.7

AL

AZ

AR

CA

CO

CTDE

FL

GA

ID

ILIN

IA

KS

KY

LA

ME

MDMA

MI

MN

MS

MO

MT

NE

NV

NH

NJ

NM

NY

NC

ND

OH

OK

OR

PA

RI

SC

SD

TN

TX

UT

VTVA

WA

WVWI

WY

Source: Olivier Jean Blanchard and Lawrence F. Katz, “Regional Evolutions,” Brookings Papers on Economic Activity 1 (1992): 1-61.

1.05 1.85

Slope = (5.5 – 4.7)/(1.05 – 1.85) = –1

Competitive Equilibrium in Multiple Labor Markets

Short-Run Impact of Immigration (Immigrants and Natives Are Perfect Substitutes)

Dollars

10

7

80 11060

If 50 (million) immigrants cross the border to work, and they and native workers are perfect substitutes, LS increases by 50 (million) workers.

Immigration increases overall employment but decreases w.

Immigration decreases the number of natives working from 80 million to 60 million because w fell.

S1

D0

S0

50 million

Immigration initially shifted out the supply curve, which raised E but lowered w.Over time, capital expands as firms take advantage of cheaper labor, shifting out the labor demand curve.The 20 million native workers reenter the labor market at the higher (previous) w

D1

Dollars

10

7

130110

S1

D0

S0

80

Long-Run Impact of Immigration (Immigrants and Natives Are Perfect Substitutes)

wN

wN

Dollars

N1N0Native E

More immigration lowers the immigrant w, increasing production because immigrant employment increases

Increased production shifts native labor demand out, increasing native w and E

DNDN

SN

wI

wI

Dollars

I1I0Immigrant E

DI

SI SI

If immigrants and natives are production complements, they don’t compete in the same labor market.

Short-Run Impact of Immigration (Immigrants and Natives Are Perfect Complements)

Wages versus immigrant share of population

-0.2

-0.1

0

0.1

0.2

-0.1 -0.05 0 0.05 0.1 0.15 0.2

Decadal change in immigrant share

De

ca

da

l c

ha

ng

e in

lo

g w

ee

kly

wa

ge

–.075 .175

Slope = [-.088 – .032] / [.175 – (-.075)] = -.48

–0.088

0.032

Immigration Surplus

Dollars

Employment

SS

0 N N+I

A

w0

w1

D

Prior to immigration, there are N native workers in the economy and national income is given by the blue trapezoid.

Immigration increases the labor supply to N + I, lowering w

However, national income increases by the pink trapezoid.

Immigrants are paid a total salary given by the pink rectangle.

The immigration surplus is given by the pink triangle. This represents the increase in national income that accrues to natives.

Firms in a competitive market hire a total of E* employees at wage w*, which maximizes the profits of all firms in the market.

Worker surplus is given by the grey triangle, while the pink triangle gives firm surplus.

The perfectly discriminating monopsonist hires the same number of workers as a competitive market, but each worker gets paid his reservation wage.

This allows it to take all of the workers’ surplus.

Dollars

S

VMPE

Employment

w*

w30

w10

3010 E*

w1

1

Noncompetitive labor markets Perfectly Discriminating Monopsonist

A nondiscriminating monopsonist pays the same wage to all workers and has estimated their labor supply equation.

Hence, the monoposonist knows the lowest wage workers are willing to accept to work at the factory in a one-factory town.

Dollars

Employment

w*

VMP

E*

wM

VMPM

MCE LS

EM

w = 5 + 2E

TCE = (w)(E)

TCE = (5 + 2E)(E)

TCE = 5E + 2E2

MCE = 5E1-1 + 2E2-1(2)

MCE = 5E0 + 4E1

MCE = 5 + 4E

Profit maximization occurs where the marginal cost of hiring = VMP

Even though the monopsonist is willing to pay w equal to VMPM it only pays workers wM because it hires only EM of the workers since it is the only game in town.

Noncompetitive labor markets Perfectly Nondiscriminating Monopsonist

Since the union has a pretty good idea how much firms value laborers, it can estimate the VMP of the firms.

Since the labor union “sells” laborers to firms, total earnings of its members can be thought of as the union’s revenue (RU)

Dollars

w*

VMP

E*

MRPM

wM

MRP

LS

EM

VMP = 25 – 3E

RU = (w)(E)

RU = (25 – 3E)(E)

RU = 25E – 3E2

MRP = 25E1-1 – 3E2-1(2)

MRP = 25E0 – 6E1

MRP = 25 – 6E

The monopolist (union) restricts the numbers of laborers it allows to become members so that it can negotiate up the wage up to VMP.

w = 25 – 3E

Noncompetitive labor markets Perfectly Nondiscriminating Monopolist

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Competitive Labor Market Equilibrium