Tutorial 12: Non-competitive Labor Markets
(cont.)
The Social Cost of Wage-setting Power
A perfectly competitive labor market delivers the greatest
social surplus. To review,
social surplus is the sum of buyers and sellers surplus.
Buyers surplus is the difference between the actual
wage paid and a buyer's reservation wage. It is a measure
of how much better off a buyer is from hiring an input such
as labor at a wage below her reservation wage. Sellers
surplus is the difference between the actual wage paid
and a seller's reservation wage. It is a measure of how
much better off a worker is from selling his labor services
at a wage above his reservation wage.
If it takes a perfectly competitive labor market, where
firms have no market power, to maximize social surplus,
what happens to it in a market where firms have market
power? In Figure 2 we see the model of a firm with wage
setting power. The firm maximizes economic profit by hiring
20,000 labor days per period, L*, and paying a wage,
W*, of $100 per day. [Do you know how
L* and W* are determined?] Now we can use this model to
compare the wage-setting firm's hiring and wage to the competitive
labor market equilibrium hiring and wage. In so doing we
can see what society loses by having a wage setting firm
hiring labor.
Figure 2
In a competitive labor market, the intersection
of demand and supply determine the equilibrium market wage
and hiring. Because this firm is the only firm hiring labor
it faces the market supply curve, S1, and its MRP is the
market demand for labor. In Figure 2 the intersection of
S1 and MRP1 would then reveal the competitive labor
market equilibrium wage, Wc, to be about $150
per day and the equilibrium hiring, Lc, to be
about 30,000 days/t.
Thus, moving from a competitive labor market
to one where firm's have market power, hiring drops from
about 30,000 to 20,000 labor days/t. In addition, wages
fall from about $150 to $100 per day. When wages fall, seller
surplus is reduced by an amount equal to the shaded areas
labeled A and C in Figure 2. Sellers surplus
falls because wages decrease and because hiring
decreases. Buyers surplus, on the other hand, is increased
by an amount equal to area A (because wages decrease)
but is reduced by an amount equal to area B (because
hiring decreases). Table 1 below summarizes and totals
the results.
Table 1
Lost sellers
surplus |
= |
-A - C |
Gained buyers
surplus |
= |
+A - B |
Deadweight loss |
= |
B + C |
The loss to society of not having labor hired
in perfectly competitive labor markets is called deadweight
loss. It measures the sum of the changes to buyers and
sellers surplus when firms develop market power.
In this Tutorial we explored a model of
the labor market where firms hiring labor have the market
power to set wages below the marginal value to the firm
of each worker hired. As a result of this market power,
social surplus in the labor market is lower than it would
be if the labor market is perfectly competitive. This
loss of social surplus comes from the reduction in wages
and the reduced hiring that result from a firm exercising
its wage-setting power. Sellers (laborers) lose sellers
surplus for both reasons. Buyers (firms) lose buyers surplus
due to the reduction in hiring, but gain buyers surplus
due to the reduction in the wage rate paid.
In the last part of Tutorial 12, we apply
both models of the labor market -- showing firms with
and without wage-setting power -- to study the impact
of a minimum wage. The question that guides our application
is "Does the minimum wage increase hiring in covered
labor markets or does it produce unemployment?"
[NOTE: The next part of Tutorial 12 has
several images and thus may be slooow to load... Please
be patient.]
Continues...
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