Competitive Labor Market Equilibrium
Dollars
Supply
whigh
w*
wlow
Demand
EDS
E*
EE
SD
Employment
In a competitive labor market, equilibrium is attained at
the point where supply equals demand.
Competitive Labor Market Equilibrium
Dollars
Supply
wmin
w*
Demand
E
EEDE* S
LF
Employment
U
The minimum wage creates unemployment (u = U/LF).
Competitive Labor Market Equilibrium
• 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
Competitive Labor Market Equilibrium
Dollars
S
The Cobweb
Model in the
Market for New
Engineers
w1
w3
w*
w2
w0
D
D
E0 E2 E*E3 E1
Employment
initial
equilibrium
wage
in produced
the
market
is eventually
w0. because
The
demand
for
engineers
to engineering
D, andinstantaneously
the wage
will
increase
tomight
w*.
Because
new
engineers
areshifts
not
and
students
misforecast future opportunities in the market, a cobweb is created as the labor market
adjusts to the increase in demand.
Competitive Labor Market Equilibrium
S0
Dollars
We don’t observe all of the shifts
S1
We observe only the first and the last
equilibriums
w0
w2
w1
D0
E0
E1
E2
D1
This looks like a demand
curve but it is not. It is
the equilibrium path
Employment
Competitive Labor Market Equilibrium
•
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.
Competitive Labor Market Equilibrium
Dollars
S (workers)
P
w*
W
D0 (firms)
E*
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)
Competitive Labor Market Equilibrium
The Impact of a Payroll Tax Assessed on Firms
Dollars
S
Total payroll tax
paid by employers
15.50
(135m)(0.5) = $67.5m
15
$1 tax
Total payroll tax
paid by employees
14.50
14
D0
(135m)(0.5) = $67.5m
D1
135 150
Employment (millions)
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 14.50
and increases the cost of hiring a worker from 15 to 15.50
Competitive Labor Market Equilibrium
The Impact of a Payroll Tax Assessed on Workers
S1
S
16
$1 tax
15.50
Total payroll tax
paid by employers
(135m)(0.5) = $67.5m
15
Total payroll tax
paid by employees
14.50
(135m)(0.5) = $67.5m
D0
135 150
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.
Competitive Labor Market Equilibrium
The Impact of a Payroll Tax Assessed on Firms and Workers
S1
Total payroll tax
paid by employers
S
15.50
$1(120m)(1)
tax
= $120m
15
Total payroll tax
paid by employees
$1 tax
14.50
(120m)(1) = $120m
D0
D1
120
150
A $1 payroll tax assessed on both firms and workers shifts the demand and supply
curves to the left.
Competitive Labor Market Equilibrium
The Impact of Payroll Tax Assessed on Firms with Inelastic Labor Supply
Dollars
S
Total payroll tax
paid by employees
15
(140m)(1) = $140m
14
D0
D1
140
Employment
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.
Competitive Labor Market Equilibrium
The Impact of Employment Subsidies
Dollars
S
Total subsidy received
by employers
$1 sub
15.50
(145m)(0.5) = $72.5m
15
14.50
D1
Total subsidy received
by employees
(145m)(0.5) = $72.5m
D0
130
145
Employment (millions)
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 $15.50
and decreases the cost of hiring a worker from 15 to 14.50
Competitive Equilibrium in Multiple Labor Markets
Dollars
SN
Dollars
SN
SS
SS
wN
w*
w*
wS
DN
Employment
(a) The Northern Labor Market
DS
Employment
(b) The Southern Labor Market
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*.
Competitive Equilibrium in Multiple Labor Markets
5.7
P e r c e n t A n n u a l W a g e G ro w th
LA
GA
NH
ME
5.5
VT
MS
VA
MD
MA
IA
AR
FL
5.3
NC
SC
KS
MI
CT
TN
AL
DE
NE
5.1
OK
TXM O
RI
PM
AN
WI
NJ
WV
IN
OH
IL CO
UT
WA
NY
KY
AZ
ND
4.9
SD
M T CA
NM
NV
4.7
ID
OR
WY
4.5
.9
1.05 1.1
1.3
1.5
Manufacturing W age in 1950
1.7
1.9
1.85
Source: Olivier Jean Blanchard and Lawrence F. Katz, “Regional Evolutions,” Brookings Papers on Economic
Activity 1 (1992): 1-61.
Slope = (5.5 – 4.7)/(1.05 – 1.85) = –1
Short-Run Impact of Immigration
(Immigrants and Natives Are Perfect Substitutes)
Dollars
S0
S1
10
7
50 million
60
80
D0
110
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.
Long-Run Impact of Immigration
(Immigrants and Natives Are Perfect Substitutes)
Dollars
S0
S1
10
7
D0
80
D1
110 130
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
Short-Run Impact of Immigration
(Immigrants and Natives Are Perfect Complements)
Dollars
Dollars
SI
SI
SN
wN
wI
wN
wI
DI
I0
I1
Immigrant E
DN
DN
N0
N1
Native E
If immigrants
and natives
are immigrant
production w,
complements,
they don’tbecause
More
immigration
lowers the
increasing production
compete inemployment
the same labor
market.
immigrant
increases
Increased production shifts native labor demand out, increasing native w and E
Decadal change in log weekly wage
Wages versus immigrant share of population
0.2
0.1
0.032
0
–0.088
-0.1
-0.2
-0.1 –.075 -0.05
0
0.05
0.1
0.15 .175
Decadal change in immigrant share
Slope = [-.088 – .032] / [.175 – (-.075)] = -.48
0.2
Immigration Surplus
Dollars
S
S
A
w0
w1
D
0
N
N+I
Employment
Prior to immigration,
N native
in the
economy and national income is
Immigrants
are paid athere
total are
salary
given workers
by the pink
rectangle.
given by the blue trapezoid.
The immigration surplus is given by the pink triangle. This represents the increase in
Immigration
increases
the labor
supply to N + I, lowering w
national income
that accrues
to natives.
However, national income increases by the pink trapezoid.
Noncompetitive labor markets
Perfectly Discriminating Monopsonist
Dollars
S
w*
w30
VMPE
w10
w1
1
10
30
E*
Employment
Firms
in a competitive
market hire
a total of E*hires
employees
at wage
w*, which
maximizes
The perfectly
discriminating
monopsonist
the same
number
of workers
as
the
profits of allmarket,
firms in but
the market.
a competitive
each worker gets paid his reservation wage.
Worker
surplus
is given
by of
thethe
greyworkers’
triangle, surplus.
while the pink triangle gives firm surplus.
This allows
it to
take all
Noncompetitive labor markets
Perfectly Nondiscriminating Monopsonist
Dollars
MCE
LS
w = 5 + 2E
TCE = (w)(E)
TCE = (5 + 2E)(E)
VMPM
TCE = 5E + 2E2
w*
MCE = 5E1-1 + 2E2-1(2)
wM
MCE = 5E0 + 4E1
MCE = 5 + 4E
VMP
EM
E*
Employment
A
nondiscriminating
monopsonist
the samecost
wage
all workers
Profit
maximization occurs
where pays
the marginal
of to
hiring
= VMP and has
estimated their labor supply equation.
Even though the monopsonist is willing to pay w equal to VMPM it only pays
Hence,
knows
wage workers
accept
workersthe
wMmonoposonist
because it hires
only the
EM lowest
of the workers
since itare
is willing
the onlytogame
in to
work
town.at the factory in a one-factory town.
Noncompetitive labor markets
Perfectly Nondiscriminating Monopolist
Dollars
VMP
w = 25 – 3E
LS
RU = (w)(E)
RU = (25 – 3E)(E)
wM
RU = 25E – 3E2
w*
MRP = 25E1-1 – 3E2-1(2)
MRPM
MRP = 25E0 – 6E1
MRP = 25 – 6E
MRP
EM
VMP
E*
Since the union has a pretty good idea how much firms value laborers, it can
estimate
the VMP
of therestricts
firms. the numbers of laborers it allows to become
The
monopolist
(union)
members so that it can negotiate up the wage up to VMP.
Since the labor union “sells” laborers to firms, total earnings of its members can
be thought of as the union’s revenue (RU)