Wage Determination

Nominal wages are the amount of money received per hour, per day, per week, and so on.

Real wages are the quantity of goods and services you can obtain with nominal wages

A calculation that you should be able to do: If nominal wages rise by 8%, and price level rises by 5%, real wages rise by 3% (8% - 5%)

Factors that Affect General Level of Wages

1. Productivity

• capital

• natural resources

• technology

• labor quality

• other factors such as business, social, and political environment

2. Dependence of wages on Productivity Level - real income per worker can increase only at about the same rate as output per worker.  You cannot pay a worker more than he produces.

3. Secular Growth and Stagnation

The productivity of American labor has increased substantially in the long run, causing the demand for labor to increase in relation to supply.  The result has been increases in real wages.

If supply and demand grow at equal rates, real wage rates are more stagnant

Wages in Particular Labor Markets

The Competitive Model

Characteristics of a competitive labor market

many firms are competing to hire a specific type of labor

numerous qualified workers with identical skills are independently supply this type of labor service.

"wage taker" behavior pertains to both firms and workers

Graphical Representation

• The market demand is determined by summing horizontally the labor demand curves (MRP curves) of individual firms

• The market supply will be determined by the amount of labor offered at different wage rates; more will be supplied at higher wages because the wage must cover the opportunity costs of alternative uses of time spent, either in other labor markets or in household activities or leisure.

• In a competitive labor market, the equilibrium wage rate Wc and number of workers employed Q1 are determined by supply SS and demand DD

• Because this wage rate is given to the individual firm hiring in the market, its labor supply curve, S = MRC, is perfectly elastic.  This implies MRC will be constant and equal to the resource price.

• The firm finds it most profitable to hire workers up to the MRP = MRC point

• Area 0abQ1 represents the firm's total revenue

• Area 0WcbQ1 is its total wage cost

• The remaining area Wcab is available for paying nonlabor resources

Monopsony Model

Characteristics:

The firm's employment is a large portion of the total employment of a particular kind of labor.

This type of labor is relatively immobile, either geographically or in the sense that, if workers sought alternative employment, they would have to acquire new skills

The firm is a "wage maker" in that the wage rate it must pay varies directly with the number of workers it employs

Graphical Representation

The labor supply curve will be upward sloping for monopsonistic firm; if the firm is large relative to the market, it will have to pay a high wage rate to obtain more labor

As a result, the marginal resource cost will exceed the wage rate in monopsony because the higher wage paid to additional workers will have to be paid to all similar workers employed.  Therefore, the MRC is the wage rate of an added worker plus the increments that will have to be paid to others already employed

Equilibrium in the monopsonistic labor market will also occur when MRC = MRP, but now the MRC is above the wage, so the wage will be lower than it would be if the market were competitive.  As a result, the monopsonistic firm will hire fewer workers than the competitive model would suggest.

  In a monopsonistic labor market, there will be fewer workers hired and at a lower wage than would be the case if that same labor market were competitive

Union Models

The purpose of unions is to try to raise wages.  They do this in many ways

 1.       Unions increase wages by increasing the demand for labor

a.       Advertising, political lobbying to protect their jobs, or forcing retention of obsolete jobs for their members

b.       Increase productivity through training more job security, better job morale, etc.

c.       increasing the price of substitutes (e.g. higher minimum wages)

Exclusive or Craft Unionism

These unions try to boost wage rates by decreasing the supply of their labor, either by large membership fees, limited training opportunities, or forcing employers to hire only union workers

Occupational licensing requirements are another way of restricting labor supply to keep wages high

Inclusive or Industrial Unionism

• Inclusive or industrial unions try to unionize every worker in a certain union so they have the power to impose a higher wage than the employer would otherwise pay.  Note that employers will hire fewer workers than they would if the workers were free to accept a lower wage.

The size of the unemployment effect depends on certain factors

• Growth in the economy - If demand is increasing, then this shift in labor demand can offset the unemployment effect of the union wage increase

• If the demand for the product and/or labor is inelastic, the wage increase will not have as much effect on employment as it would if the demand were elastic.

Bilateral Monopoly Model

This model occurs when there is a monopsonistic industry facing a unionized labor force; in other words, both the employer and employees have market power

In such a model, the outcome of the wage is indeterminate and will depend on negotiation and bargaining power.

·         A union will seek the highest wage possible (Wu) while the employer will seek a lower wage (We).  Where the wage rate is depends on which has more power.  If the union has more power, the wage will be closer to Wu.  If the employer has more power, the wage will be closer to We.

·         A bilateral monopoly may be more desirable than one-sided market power.  In other words, if a competitive market does not exist, it may be more socially desirable to have market power on both sides of the labor market, so that neither side exploits the other.

The Minimum Wage Controversy

• The case against minimum wage

  • The minimum wage forces employers to pay a higher than equilibrium wage, so they will hire fewer workers as the wages pushes them higher up their MRP curve

  • Most minimum wage workers are teens from affluent families who do not need protection from poverty.

The case for minimum wage

• Minimum-wage laws occur in markets that are not competitive and not static.  In a monopolistic market, the minimum wage increases wages with minimal effects on employment

• Increases minimum wage increases productivity.

  • Managers will use more efficiently when they have higher wages.  This is called the "shock effect"

  • Workers will be more productive if they have more motivation, and higher real wages could improve health and vigor.

Reasons for Wage Differences

1. Workers are not homogenous

• Workers have different ability levels

• There are different amounts of "investment in human capital" among workers.  This refers to the education people receive.

2. Nonmonetary aspects such as working conditions, location, etc.

3. Since market imperfections exist, labor markets are not perfectly competitive  

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