2016-1 Labor Economics

Unit 6. Friction in labor market

Prof. Min-jung, Kim

Department of Economics

Wonkwang University

Textbook : Modern Labor Economics: Theory and Public policy written by Ronald G. Ehrenberg

This power point slides are written using the “Modern Labor Economics: Theory and Public policy”

The Law of One Price (LOP)

Workers who are of equal skills within occupations will receive the same wage – there will be no wage differentials.

• Assumptions underlying the LOP:

• Every employee has information about available jobs – information is costless.

• Mobility or job search across employers is costless.

• Labor supply curve is horizontal.

Mobility or job search across employers is NOT costless.

• Job search takes time and effort.

• Costs of job search include:(a) application – printing résumés and postage(b) interview – buying expensive clothes for interview

and roundtrip fares(c) travel – hiring movers if employed(d) psychological costs – missing friends and family

members.

Costs of job search/mobility make the supply curve to be upward sloping and not horizontal as assumed earlier.

Higher mobility costs will elicit low labor/employment responses if wage changes.

Lower mobility costs will elicit high labor/employment responses if wage changes.

Monopsonistic Labor Markets: A Definition

A labor market monopsonist is the only buyer/employer of labor in its labor market.

The employer faces an upward labor supply curve but its MEL (or MCL) is much higher than the wage rate.

Profit Maximization under Monopsonistic Conditions

Recall that:• profit-maximizing firms will hire as long as MRPL > MEL

• hiring stops when MRPL = MEL

• when firms face upward sloping supply curves, the MEL exceeds the wage.

Why the Marginal Expense of Labor Exceeds the Wage Rate

• The marginal expense of labor (MEL) exceeds the wage rate because:

potential employees find it costly to change jobs, so the firm must be willing to pay higher wages to attract workers from other employers,

the MEL includes to the wages paid to the extra worker plus the additional cost of raising the wage for all other workers.

Table 5.1

Figure 6.2 A Graph of the Firm-Level Data in Table 5.1

The Firm’s Choice of Wage and Employment Levels

• The monopsonist hires workers up to the point where:

MRPL = MEL (5.1)

• The labor market effects caused by MEL > W :

A labor market monopsonist hires less workers in comparison to the competitive employer(s).

A labor market monopsonist pays a wage that is less than the competitive wage – exploits workers.

Figure 6.3 Profit-Maximizing Employment and Wage

Levels in a Firm Facing a Monopsonistic

Labor Market

Monopsonistic Conditions and Firms’ Wage Policies

• The employers in monopsonistic labor markets must decide on the wage to pay unlike in the perfectly competitive labor markets where firms are wage takers.

• Firms must make labor market decisions that allow them to remain competitive in their product markets.

• Product and labor market constraints may cause firms in monopsonisticlabor markets to offer different wages to equivalent workers.

• Due to the unlikelihood that SL and MRPL curves would be exactly the same for different firms in the same labor market, it should be no surprise if exactly comparable workers have different marginal productivities and receive different wages at different firms.

How Do Monopsonistic Firms Respond to Shifts in the Supply Curve?

The labor market monopsonistic firm does not really have a labor demand curve – it has MRPL curve.

The monopsonistic firm is not a wage taker and its MRPL curve shows various levels of employment of which there is only one profit-maximizing level of employment and only one associated wage rate.

Shifts in Labor Supply Curve That Increase MEL

•If fewer workers are willing to work and the labor supply shifts to the left, the short-run effects are:

employment level (E) will fall to E’ and the market wage (W) will increase to W’

MEL will also shift to a higher level (ME’L).

Figure 6.4 The Monopsonistic Firm’s Short-Run Response to

a Leftward Shift in Labor Supply: Employment

Falls and Wage Increases

In the long run, the monopsonistic firm’s cost minimizing mix of c

apital (K) and labor (L) would require:

Similar to equations:

(3.7a) P. MPL = MEL (remember that MEL > W)

(3.7b) P.MPK = C

(3.8a)

(3.8b)

(5.2)

L

L

K

L

L K

MEP

MP

CP

MP

ME C

MP MP

(3.8c)

Effects of a Mandated Wage

•A mandated wage (Wm) prevents a firm from paying a wage less than Wm –this creates a perfectly elastic labor supply curve facing the firm, thus altering its MEL curve.

•A profit-maximizing firm will hire labor where the MRPL insects the perfectly elastic labor supply curve (MEL curve) created by Wm – see employment at Emin Figure 5.5.

•For a monopsonistic firm, Wm can simultaneously increase the average cost

of labor and reduce MEL – the decrease in marginal expense will induce the firm to expand output and employment in the short run.

Figure 6.5 Minimum-Wage Effects under Monopsonistic Conditions: Both Wages

and Employment Can Increase in the Short Run

BDS = Labor supply curve based on a mandated WmBDEM = Marginal expense of labor curve (MEL) based on WmMRPL = MEL (which is given as BDEM based on Wm) → Em

Monopsonistic Conditions and the Employment Response to Minimum

Wage Legislation

Legislated increases in Wmin raise wages.

Modest increase in Wmin can reduce MEL.

Fall in MEL may cause some firms/employers to experience increases in employment.

Higher total labor costs due to Wmin may force some firms/employers to close.

Job Search Costs and Other Labor Market Outcomes

Despite the job search costs, some workers’ high wage levels may be due to luck – they are lucky to be employed by a high-paying/high-productivity

employer.

Job mobility/search costs for workers may explain why:

• Wages increase or improve over time with workers’ labor market experience or activity.

• Wages increase with workers’ length of time (tenure) with their

particular employers.

Wage Levels, Luck, and Search

• Employee mobility costs can create, other things equal, monopsonisticconditions that result in pay differences among workers who have equal productive capabilities.

• The implication is that to some extent, a worker’s wage depends on luck – some

workers will be lucky to obtain a job offer from high-paying employer.

• Workers who see their jobs as a poor match (due to low pay) have more incentive to search for other offers than the lucky ones who have good matches with high wages.

• Labor-market studies have observed that workers’ wages tend to increase both with(1) overall labor market experience, and(2) holding labor market experience constant, the length of time with one’s employer

(“job tenure”).

Wage and Labor Market Experience

• Workers who have spent more time in the labor market have had more chances to acquire better offers and thus improve upon their initial job matches –that is, workers’ wages improve the longer they are active in the labor market.

Wages and Job Tenure

• With costly job searches, workers who are fortunate enough to find jobs with high-paying employers will have little incentive to continue searching.

• Those who have longer job tenure with their employers also

tend to have higher wages.

Monopsonistic Conditions and the Relevance of the Competitive Mo

del

Job Search Costs and Unemployment

• Job search costs can help to explain the existence (and level) of unemployment – the longer it takes for a worker to receive an acceptable offer, the longer the unemployed worker will remain unemployed.

The competitive model may offer predictions that are at least partially contradicted by evidence but it does not mean that it is irrelevant, especially in the long run.

The major difference between the competitive and monopsonistic models is the assumption about employee mobility costs.