Tutorial 12: Non-competitive Labor Markets
(cont.)
An Application -- The Employment Effect
of a Minimum Wage
In this part of Tutorial 12, we apply both
models of the labor market -- 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?"
A Two-sector Model
of Labor Employment
In Tutorial 3e
we learned that attempts to regulate the market price in
order to produce a "more fair" price (for at least
one group) lead to a loss of social surplus. A minimum wage
is an example of such an attempt. To review, a minimum
wage is a "price floor" (or a "price
support"), a legal minimum price, set by the government,
to hold wage rates above that determined by the market for
labor. For simplicity, we will divide the market for this
type of labor into two sectors, one sector covered by the
minimum wage ("Covered Sector") and one "Not
Covered Sector". Figures 3 and 4 offer illustrations
of each. Before the government imposes a minimum wage, the
competitive wage, W*, is $100 per unit and the competitive
level of hiring, L*, is 200 units per time period (t).
Suppose the government sets a minimum wage
in the covered sector (Min w) at $130 per unit of
labor. At that wage, the quantity of labor demanded
is 140 and the quantity of labor supplied
is 260 units/t. This leaves a labor surplus
of 120 units/t.
Figure 3 - Covered Sector
Suppose the "units" in this market
are workers. That means that establishing a minimum wage
has resulted in 120 workers who are unable to find work.
Of those, (200 - 140) = 60 workers had a job but were laid
off when the market decreased the quantity of labor demanded
as wages rose. The remaining 60 workers entered the market
attracted to the increase in wages only to find that no
additional jobs were available. Both groups are part of
the unemployed, however.
Some of these 120 workers will seek work in
markets not covered by the minimum wage. The result
of their migration is shown in Figure 4. The supply
of labor increases as workers enter this market "not
covered" by the minimum wage. The increase in supply
drives wages down to $80 per unit, and does increase hiring
to 240 units/t.
Figure 4
So a minimum wage will generate unemployment
in the covered sector and reduce wages in the uncovered
sector. Although not the goal of the legislation governing
minimum wages, it is a logical outcome!
Minimum Wage and Monopsony
But suppose the market for labor is not
made up of a large number of independent labor buyers with
no wage-setting power. Suppose the labor market in the covered
sector is best described as a monopsony. Will the
result of a minimum wage be different? Let's use the labor
market model developed in this Tutorial and see if our conclusion
changes. Figure 5 offers an illustration.
Before the imposition of a minimum wage, the
wage rate in this market, W*, is $100 per unit and
the wage-setting firm hires, L*, 20000 units of labor
per period. (Note: Although these numbers are the same as
in the previous example, remember that they are the result
this firm exercising its wage-setting power to reduce wages
and hiring below competitive market conditions.) A government
set minimum wage, Min w, forces the firm to be a
wage taker. The dashed lines now show the firms new S and
ME curves. Along the horizontal portion of the dashed line,
w = ME. Where that line hits the market supply curve shows
us how many workers the firm will be able to hire at the
minimum wage rate it must pay. That number is about 26000
units of labor per period. [Why would the firm hire 26000
workers? Following the vertical portion of the dashed line
we see that even the last worker hired has a MRP greater
than the wage rate. This means that the firm is still earning
a profit on this, and all previous, workers hired. Profit
is not a a maximum here, but it is still positive!]
So imposition of a minimum wage in a labor
market controlled by a monopsonist results in an increase
in hiring from 20000 to 26000 units/t.
Figure 5
Conclusion
We started this inquiry with the question
"Does the minimum wage increase hiring in covered labor
markets or does it produce unemployment?" The answer,
as often is true in economic analysis, is "It depends...".
On the one hand, if the sector of the labor market covered
by a minimum wage is perfectly competitive, then a minimum
wage will cause an increase in unemployment among those
workers whose income such a wage was designed to increase.
On the other hand, if the sector of the labor market covered
by a minimum wage is a monopsony, then a minimum wage will
cause an increase in employment, and with that, an increase
in the incomes of the workers as intended.
The End!
This concludes the Tutorials for this course!
Now it's time to put together what you have learned about
the operation of competitive markets in both Tutorial
9 and Tutorial
11. In Project
4, you will explore the interactions between the competitive
market for products and the competitive market for labor.
Using an Excel workbook
to model the interactions, you will answer a series of
questions that asks why the models behaves as they do
in response to a change in the markets' initial conditions.
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