Chapter 12
Labor Markets and Labor
Unions
© 2006 Thomson/South-Western
1
Three Uses of Time
Individuals can use their time in three
ways
Undertake market work  selling time in
the labor market in return for income
Undertake nonmarket work  using time to
produce their own goods and services
Spend time as leisure  all nonwork uses of
their time
2
Work and Utility
 Work is not a pure source of utility, rather it is a
source of disutility  the opposite of utility
 Net utility of work -- the utility of consumption
made possible through work minus the disutility of
the work itself; usually makes some amount of
work an attractive use of part of an individual’s
time
 In the case of market work, the individual’s income
buys goods and services
3
Utility Maximization
Within the limits of a 24-hour day, seven days a
week, individuals can balance their time among
market work, nonmarket work, and leisure in
order to maximize utility
The rational consumer will attempt to
maximize utility by allocating time so the
expected utility of the last unit of time spent in
each activity is identical
4
Implications
The higher your market wage, other things
constant, the higher your opportunity cost of
leisure and nonmarket work
The higher the expected earnings right out of
high school, other things constant, the higher
the opportunity cost of attending college
5
Wages and Individual Labor Supply
An increase in the wage affects an
individual’s choice between market
work and other uses of time in two
ways:
Substitution Effect
Income Effect
As wage increases, market work is
substituted for other activities 
substitution effect of a wage increase
6
Income Effect
A higher wage means a higher income for the
same number of hours, so demand for all
normal goods increases
Leisure is a normal good, so higher income
increases the demand for leisure and the
allocation of time to market work declines
The income effect of a wage increase tends to
reduce the quantity of labor supplied to market
work
7
Exhibit 1: Individual Labor Supply Curve for Market Work
The individual
supply curve slopes
upward until a wage of
$12 is reached: at $12,
the substitution effect
dominates – the
quantity of labor
supplied increases
After a wage of $12,
the labor supply curve
bends backward and
the income effect
dominates – the
quantity of labor
supplied decreases
8
Nonwage Determinants of Labor Supply
Supply of labor to a particular market depends
on a variety of factors other than the wage
Other sources of income
Nonmonetary factors
Value of job experience
Taste for work
9
Other Sources of Income
The willingness to supply time to a labor
market depends on income on other sources,
including prior savings, borrowing, family
support, and similar sources
More generally, wealthy people have less
incentive to work
10
Nonmonetary Factors
Difficulty of the job: the more difficult the job,
the higher the wage must be, all other things
being equal
Quality of the work environment: the more
attractive the working conditions, the more
labor an individual will supply to that
particular market, other things constant
Status of the position: the higher the status, the
more labor an individual will supply to that
market, other things constant
11
Exhibit 2: Market Labor Supply Curve
The labor supply curves of different individuals do not bend
backwards at the same time – here we have three individual supply
curves that sum to a market supply curve that slopes upward over the
realistic range of wages
12
Why Wages Differ
Wage differences across markets trace to
differences in a number of factors
Differences in training, education, age, and
experience
Differences in ability
Differences in risk
Geographic differences
Job discrimination
Union membership
13
Exhibit 3 Average Hourly Wage By Occupation
14
Why Wages Differ
Training, Education, Age, and Experience
Some jobs pay more because they require a
long and costly training period
 Fewer
individuals are willing to incur the time
and expense required
 Results in a smaller market supply
However, extensive training increases the
productivity of labor
 There
is increased demand for these skills
15
Exhibit 4 Age, Education, and Pay
16
Why Wages Differ
Differences in ability
Ability
Risk
Geographics
Job discrimination
Union membership
17
Types of Unions
A labor union is a group of workers who
join together to improve their terms of
employment
Craft unions are confined to those with a
particular skill, or craft
Industrial unions include unskilled,
semiskilled, and skilled workers in a
single industry, such as all autoworkers
or all steelworkers.
18
Collective Bargaining
Collective bargaining
Process by which representatives of union and
management negotiate a mutually agreeable
contract specifying wages, employee benefits, and
working conditions
Mediator
An impartial observer who listens to both sides
separately and then suggests how each side could
adjust its position to resolve differences
Binding arbitration
Process whereby a neutral third party evaluates
both sides of the dispute and issues a ruling that
both parties must accept
19
The Strike
A strike is a union’s attempt to withhold
labor from the firm
Purpose of a strike is to stop production,
thereby forcing the firm to accept the
union’s position
Strikes also impose significant costs on
union members
20
Union Wages and Employment
A menu of union desires includes higher
wages, more benefits, greater job security,
better working conditions, and so on
Three ways that a union can try to
increase wages
By forming an inclusive, or industrial, union
By forming an exclusive, or craft, union
By increasing the demand for union labor
21
Exhibit 5: Effect of a Union’s Wage Floor
In the absence of a union, equilibrium wage is
W and equilibrium employment level is E.
At the market wage, individual employers face a
horizontal, or perfectly elastic, supply of labor, s.
Wage rate
(a) Industry
(b) Firm
Wage rate
S
W
s
W
d = Marginal
revenue product
D
E
Labor per period
e
Labor per period
Each firm can hire as much labor as it wants at the market wage of W
A firm hires up to the point where labor’s marginal revenue product equals its
marginal resource cost, quantity e
22
Exhibit 5: Effect of a Union’s Wage Floor
•If the union negotiates a wage above the market-clearing wage at W‘, no labor will be supplied at a
lower wage. In effect, the supply of union labor is perfectly elastic at the union wage out to point a.
•If more than E'‘ workers are demanded, the wage floor no longer applies and the upward-sloping
portion, aS, becomes the relevant part of the labor supply curve W'aS.
W'
(b) Firm
S
Wage rate
Wage rate
(a) Industry
a
W
W'
s'
W
s
d = Marginal
revenue product
D
E E''
Labor per period
e
Labor per period
For an industry facing a wage floor of W', the entire labor supply curve is W'aS ,which has
a kink where the wage floor joins the upward-sloping portion of the original supply curve.
23
Exhibit 5: Effect of a Union’s Wage Floor
Once this wage floor has been established, each firm faces a horizontal supply curve of
labor at the collectively bargained wage, W’. Since the wage is now higher, the quantity of
labor demanded by each employer declines from e to e' as seen in the right panel.
(a) Industry
(b) Firm
Wage rate
Wage rate
S
a
W'
W
W'
s'
W
s
d = Marginal
revenue product
D
E'
E E'' Labor per period
e'
e
Labor per period
The higher wage leads to a reduction in total employment as shown by the decline from E to E'
in the left panel. Each firm faces a horizontal supply curve of labor at the collectively
bargained wage  quantity of labor demanded by each employer declines from e to e’
24
Exhibit 5: Effect of a Union’s Wage Floor
At wage W’, the amount of labor that workers would like to supply, E”, exceeds the amount
demanded, E’. In the absence of a union, this excess quantity of labor supplied would cause
unemployed workers to lower their asking wage. With a union, workers cannot offer to
work for less, nor can employers hire them at a lower wage.
a
W'
(b) Firm
S
Wage rate
Wage rate
(a) Industry
W
W'
s'
W
s
d = Marginal
revenue product
D
E'
E E'' Labor per period
e'
e
Labor per period
Because of the excess quantity of labor supplied, the union must somehow ration available jobs,
such as awarding jobs based on worker seniority or connections with the union
25
Effect of Union Wage Floor
With the inclusive, or industrial, union the
wage rate is higher and total employment lower
than would be in the absence of a union
Those who cannot find union employment will
look for jobs in the nonunion sector, causing
the nonunion wage to be driven downward
Wages are relatively higher in the union sector
for two reasons
Unions bargain for wage higher than the marketclearing wage
Those unable to find employment in the union sector
crowd into the nonunion sector
26
Exhibit 6 Median Weekly Earnings Are Higher
for Union Than Nonunion Workers
27
Exhibit 7a: Effect of Reducing Labor Supply
A successful
supply
restriction
would be
shown as the
leftward shift
from S to S'.
28
Reducing Labor Supply
A successful supply restriction
Requires that the union:
limit its membership
force all employers in the industry to hire only
union members – a craft union
Membership can be restricted with high initiation fees,
long apprenticeship periods, difficult qualification
exams, and other devices
Defended on the grounds that they protect the public
29
Exhibit 7b: Effect of Increasing Labor Demand
Third way of
increasing wages is if
the union can somehow
increase the demand
for labor by causing
the demand curve to
shift from D to D“
This is a more
attractive alternative
because it increases
both the level of
employment – E to E''–
and the wage rate – W
to W' – there is no need
to ration jobs among
union members
30
Increasing the Demand for Labor
Increase demand for union-made goods
Restrict supply of nonunion-made goods
Increase productivity of union labor
Some claim that unions increase worker
productivity by minimizing conflicts, resolving
differences, and monitoring workers
If this is indeed true, the demand for union labor
should increase
Featherbedding
31
Featherbedding
Union efforts to force employers to hire
more workers than wanted or needed
 Does
not create a true increase in the
demand, in the sense of shifting the demand
curve to the right
Instead, forces firms to hire more labor than
they really want or need, thus moving the
firm to a point to the right of its true labor
demand curve
32
Recent Trends in Union Membership
In 1955, about one-third of wage and salary
workers belonged to unions, now only one in
seven belongs to a union
Government workers make up nearly half of all
union members
Compared with other industrialized countries,
the U.S. ranks relatively low in terms of
unionization
33
Recent Trends in Union Membership
Union membership rates vary greatly across
states
Rates tend to be highest in the Northeast United
States and lowest in the South
Decline in union membership is due partly to
structural changes in the U.S. economy
Employment in the industrial sector has been
declining, and increasing in the service sector
Growth in foreign competition
Near disappearance of strikes
34
Exhibit 8 Unionization Rates by Age and
Gender
35