chapter 9 labor economics. copyright © 2008 pearson addison wesley. all rights reserved. 29-2...

Chapter 9

Labor Economics

Copyright © 2008 Pearson Addison Wesley. All rights reserved. 29-2

Introduction

Technovate and 24/7 sound like U.S. based firms, but in fact, they are located in India.

The companies offer low-cost labor services to U.S. firms in need of customer service.

Many U.S. politicians assert these and other Indian call centers are “stealing” U.S. jobs.

This chapter will help you evaluate this claim.


Did You Know That...

• The principles we have used to explain the market in which goods are sold will also describe the labor market?

• Profit-maximizing firms will hire labor up to the point where the marginal benefit equals the marginal cost?


Labor Demand for a Perfectly Competitive Firm

• We will start our analysis under the assumption that the market for input factors is perfectly competitive.

• We will further assume that the output market is perfectly competitive.

• This provides a benchmark against which to compare other labor markets or product markets that are not perfectly competitive.


Labor Demand for a Perfectly Competitive Firm (cont'd)

• Assumptions

Each employer is one of a very large number of employers.

Workers do not need special skills.

Workers are free to move from one employer to another.

The firm is a price taker in the labor market.



• Marginal Physical Product (MPP) of Labor

The change in output resulting from the addition of one more worker

The change in total output accounted for by hiring the worker, holding all other factors of production constant

Eventually declines because of the law of diminishing marginal product



• Marginal Revenue Product (MRP)

The marginal physical product (MPP) times the marginal revenue (MR)

The additional revenue obtained from a one-unit change in labor input



• The marginal revenue product represents the incremental worker’s contribution to the firm’s total revenues.


Figure 29-1 Marginal Revenue Product, Panel (a)


Figure 29-1 Marginal Revenue Product, Panel (b)



• Marginal Factor Cost (MFC)

The cost of using an additional unit of an input

For example, if a firm can hire all the workers it wants at the going wage rate, the MFC of labor is the wage rate.

Marginal factor cost =Change in total cost

Change in amount of resources used



• In a perfectly competitive labor market

The market determines the wage

The individual employer is a wage taker

All workers are hired for the same wage

MFC = wage



• The MRP curve demand for labor

The MRP curve is the demand curve for labor for the firm.

This tells us how many workers will be hired at various possible wage rates.

The firm will hire any worker who can contribute to revenues by more than they contribute to costs.



• General rule for hiring

The firm hires workers up to the point at which the additional cost associated with hiring the last worker is equal to the additional revenue generated by hiring that worker.



• Derived Demand

The factors of production are needed to manufacture a final good or to provide a final service.

Thus, the demand for labor is influenced by demand for the final product.


Figure 29-2 Demand for Labor, a Derived Demand


The Market Demand for Labor

• The downward-sloping portion of each firm’s MRP curve is also its demand curve for labor.

• When we go to the entire market for labor, we will also find that the quantity of labor demanded varies inversely with wage rate changes.


Figure 29-3 Derivation of the Market Demand Curve for Labor

• Wage rate of $20• Firms will hire

2,000 workers

• Wage rate of $10• Firms will hire

3,000 workers


The Market Demand for Labor (cont'd)

• Price elasticity of demand for labor similar to elasticity for goods

• Percentage change in quantity demanded divided by percentage change in price of labor Inelastic < I

Unit-elastic = 1

Elastic > 1


Determinants of Demand Elasticity for Inputs

• The price elasticity of demand for a variable input will be greater

1. The greater the price elasticity of demand for the final product

2. The easier it is to employ substitute inputs

3. The larger the proportion of total costs accounted for by the particular variable input

4. The longer the time period available for adjustment


Wage Determination in a Perfectly Competitive Labor Market

• Having developed the demand curve for labor in a particular industry, let’s turn to the labor supply curve.

• By adding supply to our analysis, we can determine the equilibrium wage rate that workers earn in an industry.

• We can think in terms of a supply curve for labor that slopes upward in a particular industry.


Figure 29-4 The Equilibrium Wage Rate and the Electronic Organizer Industry


International Example: A Global Shortage Hits the Market for Mining Workers

• Manufacturing industries in nations such as India and China have grown rapidly during the 2000s.

• Demand for mined commodities (aluminum, copper, zinc, nickel) used as manufacturing inputs has soared.


International Example: A Global Shortage Hits the Market for Mining Workers (cont'd)

• Commodity prices have increased, which has raised the MRP of a key production input—mine workers.

• The quantity of qualified mining labor demanded has been pushed above the quantity of qualified labor supplied.

• Managers of mining companies commonly try to hire away other firms’ workers promising higher wages.


Shifts in Market Demand for and the Supply of Labor

• Reasons for labor demand curve shifts

1. Change in demand for the final product

2. Change in labor productivity

3. Change in the price of related inputs


Reasons for Labor Demand Curve Shifts

• A change in the demand for the final product that labor is producing will shift the market demand curve for labor in the same direction.

• A change in labor productivity will shift the market labor demand curve in the same direction.


Reasons for Labor Demand Curve Shifts (cont'd)

• A change in the price of a substitute input will cause demand for labor to change in the same direction.

• A change in the price of a complimentary input will cause the demand for labor to change in the opposite direction.


Reasons for Labor Supply Curve Shifts

• Labor supply curves may shift in a particular industry for a number of reasons.

1. Change in wages in other industries

2. Changes in working conditions

3. Job flexibility


Labor Outsourcing, Wages, and Employment

• Outsourcing

A firm’s employment of labor outside the country in which the firm is located


Labor Outsourcing, Wages, and Employment (cont'd)

• Outsourcing

Some U.S.-based companies outsource labor to other countries.

Some firms based around the globe outsource labor to the United States.


Figure 29-5 Outsourcing of U.S. Computer Technical-Support Services



• Question How are U.S. workers affected?

• Answers If cheaper labor is available in other countries, this

will dampen the demand for U.S. labor.

But as the volume of global commerce rises, there may be more of a demand by foreign firms to hire U.S. workers as well.



• Labor outsourcing by U.S. firms tends to reduce U.S. wages and employment.

• Whenever foreign firms engage in labor outsourcing to the United States, however, U.S. wages and employment increase.


Figure 29-6 Outsourcing of Accounting Services by Canadian Firms



• Short-run effects

Even in the best of times, workers experience short-run ups and downs in wages and jobs.

In the United States, after all, about 4 million jobs come and go every month.

To be sure, in the near term, workers earn lower pay and experience reduced employment.



• Long-term benefits

Labor allows for more specialization, which enhances trade.

If goods are produced and services are performed in those countries where the opportunity costs are lowest, then global economic growth is enhanced.



• Expanded production and consumption possibilities made possible by outsourcing and other forms of international trade generate higher total revenues across U.S. firms.



• Benefits for U.S. workers

Firms can outsource their labor needs and will operate more efficiently.

This means that the products they sell have lower prices.

In turn, each dollar in a worker’s paycheck has a greater purchasing power.



• In the long run, outsourcing helps boost the overall value of MRP in industries throughout the U.S. economy.

• Consequently, the ultimate long-run effect of outsourcing is an increase in demand for labor in most industries.

• Increased labor demand pushes up wages and boosts employment, and economists estimate outsourcing has created more jobs than it has destroyed.



• International labor outsourcing is also known as “labor offshoring.”

• One U.S. firm has found a way to literally engage in “offshore” outsourcing activities.


E-Commerce Example: Outsourcing Computer Programming Very Close to the Border

• A company called SeaCode has hundreds of workers from nations such as India and Russia on a cruise ship off the U.S. coast.

• Most of the workers are computer programmers that SeaCode hires to write software for U.S. businesses.

• In this way, people from abroad who cannot obtain immigration visas can earn roughly $1,800 per month.


Monopoly in the Product Market (cont'd)

• Question Why does the monopolist hire fewer workers?

• Answer The marginal benefit to the monopolist of hiring

an additional worker is affected by the fact that the monopolist faces a reduction in the price charged on all units in order to be able to sell more of her product.


The Utilization of Other Factors of Production

• Profit maximization revisited

MRP of labor = Price of labor (wage)

MRP of land = Price of land (rent)

MRP of capital = Price of capital (cost per unit of service)


The Utilization of Other Factors of Production (cont'd)

• Cost minimization

To minimize total costs for a particular rate of production, the firm will hire factors of production up to the point at which the marginal physical product per last dollar spent on each factor is equalized.


The Utilization of Other Factors of Production (cont'd)

• Cost minimization

MPP of labor

Price of labor=

MPP of capital

Price of capital

MPP of land

Price of land=


Issues and Applications: Now Indian Outsourcing Specialists are Also Outsourcing

• An outsourcing specialist chooses to outsource.

• Indian outsourcing firms increasingly look abroad for talent.

• For India, outsourcing has become a two-way street.


Introduction

What are labor unions?

What are the objectives of unions, and what strategies do they utilize to pursue their goals?

Why have the aims of some unions recently clashed with others?


Did You Know That...

• Half of U.S. labor union members are in only six states?

• Once a union represents all the workers who supply a particular type of labor, an element of monopoly power replaces the competitive outcome?


Industrialization and Labor Unions

• Labor Unions

Worker organizations that seek to secure economic improvements for their members

They also seek to improve safety, health, and other benefits (such as job security) of their members.


Industrialization and Labor Unions (cont'd)

• Craft Unions Labor unions composed of workers who engage

in a particular trade or skill

• Collective Bargaining Negotiation between the management of a

company or of a group of companies and the management of a union or group of unions for the purpose of reaching a mutually agreeable contract that sets wages, fringe benefits, and working conditions for all employees in all unions



• Unions in the U.S.

Knights of Labor

American Federation of Labor



• Early labor issues

8-hour workday

Equal pay for men and women



• The formation of industrial unions

National Industrial Act of 1933

National Labor Relations Act 1935, otherwise known as the Wagner Act



• The Congress of Industrial Organizations (CIO) was formed in 1938.

It was composed mainly of industrial unions.

Prior to the formation of the CIO, most labor organizations were craft unions.



• Industrial Unions

Labor unions that consist of workers from a particular industry, such as automobile manufacturing or steel manufacturing



• Congressional control over labor unions

The Wagner Act (1935)

Gave unions the right to organize workers and to engage in collective bargaining




Taft-Hartley Act of 1947

Allowed right-to-work laws Laws that make it illegal to require union

membership as a condition of continuing employment in a particular firm





Made closed shops illegal A business enterprise in which employees must

belong to the union before they can be hired and must remain in the union after they are hired

A union shop however, is legal Non-union members join later





Prohibited jurisdictional disputes Disputes involving two or more unions over which

should have control of a particular jurisdiction





Prohibited sympathy strikes A strike by a union in sympathy with another union’s

strike or cause





Prohibited secondary boycotts A boycott of companies or products sold by

companies that are dealing with a company being struck





Established the 80-day cooling-off period

A court injunction can be used to delay a strike if it would imperil the nation’s safety or health.



• The current status of labor unions: we consider

Worldwide trends in unionization

U.S. unionization trends


Figure 30-1 Union Membership as a Share of Total Employment in Selected Nations


Figure 30-2 Decline in Union Membership



• Explaining the fall in union membership

Deregulation

Immigration

Shift from manufacturing to services


Table 30-1 The Ten Largest Unions in the United States


Union Goals and Strategies

• Strikes: the ultimate bargaining tool

Purpose is to impose costs and reduce profits of the employer

Workers do not receive wages during the time of the strike, but they may receive some compensation from the union strike fund.


Union Goals and Strategies (cont'd)

• Strikebreakers can reduce the bargaining power of the strike

Temporary or permanent workers hired by a company to replace union members who are striking



• One of the major roles of a union that establishes a wage rate above the market clearing wage rate is to ration available jobs among the excess number of workers who wish to work in unionized industries.


Figure 30-3 Unions Must Ration Jobs



• Unions must ration the available jobs by

Seniority

Apprenticeship



• Union wage and employment strategies

Employ all union members

Maximize member income

Maximize wages for certain workers


Figure 30-4 What Do Unions Maximize?


Example: To Save Members Jobs, the UAW Agrees to a Two-Tier Pay Scale

• Many of DaimlerChrysler’s Jeep vehicles are assembled in two plants located in Toledo, Ohio.

• In an effort to reduce hourly wage costs, some pre-assembly work was shifted out of these plants.


Example: To Save Members Jobs, the UAW Agrees to a Two-Tier Pay Scale (cont'd)

• To preserve union jobs, the UAW agreed to adopt a two-tier wage system at the Toledo Jeep plants.

• Workers who specialize in final assembly make $26 per hour; those in pre-assembly make $15 per hour.



• Union strategies to raise wages indirectly

Limit entry over time

Alter demand for union labor



• Limiting entry over time

One way to raise wage rates without specifically setting wages is for a union to limit the size of its membership to the size of its employed workforce when the union was first organized.


Figure 30-5 Restricting Supply over Time

If union membership limited to Q1, wages increase to 21 instead of 20 and employment is reduced



• The demand for union labor can be increased by

1. Increasing worker productivity

2. Increasing the demand for union-made goods

3. Decreasing the demand for non-union-made goods


Economic Effects of Labor Unions

• Do union members earn higher wages?

• Are they more or less productive than nonunionized workers?

• What are broader economic effects of unionization?


Figure 30-6 The Most Heavily Unionized Occupations in the United States


Economic Effects of Labor Unions (cont'd)

• Unions are able to raise wages if they can successfully limit the supply of labor in a particular industry.

• Economists estimate that the average union wage premium is $2.25 an hour.

• Yet annual earnings for union workers are not necessarily higher, because they may work somewhat fewer hours.



• Question How do unions affect labor productivity?

• Answers There is some evidence that

featherbedding creates inefficiency in the unionized industries.

But some economists argue that unions actually enhance productivity by reducing labor turnover.



• Featherbedding

Any practice that forces employers to use more labor than they would otherwise or to use existing labor in an inefficient manner



• Economic benefits and costs of labor unions—two opposing views

1. Unions are monopolies whose main effect is to raise the wage rate of high seniority members.

2. Unions increase labor productivity by promoting generally better work environments.


Monopsony: A Buyer’s Monopoly

• Assumptions

Firm is perfect competitor in the product market: it cannot alter the price of the product it sells, and it faces a perfectly elastic demand curve for its product.

One factory not only hires the workers but also owns all the businesses in the town, this buyer of labor is called a monopsonist, the single buyer.


Monopsony: A Buyer’s Monopoly (cont'd)

• The monopsonist faces an upward-sloping supply curve of labor.

• Consequently, the marginal factor cost of increasing the labor input by one unit is greater than the wage rate.

• Thus the marginal factor cost curve always lies above the supply curve.


Monopsony: A Buyer’s Monopoly (cont'd)

• Monopsonistic Exploitation Paying a price for the variable input that is

less than the marginal revenue product

The difference between marginal revenue product and the wage rate

• Bilateral Monopoly A market structure consisting of a

monopolist and a monopsonist


Competition in Buying and Selling!

• SELLING BUYING

• Pure Competition Pure Competition

• Monopolistic Comp Monopsonistic Comp

• Oligopoly Oligopsony

• Monopoly Monopsony


Figure 30-11 Membership Shares for Unions in the Change to Win Federation versus Unions Remaining in the AFL-CIO

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 9-92

Key Terms and Concepts

• boycott

• collective bargaining

• craft union

• derived demand

• income distribution

• income effect

• industrial union

• labor productivity

• labor unions

• marginal factor cost (MFC)

• marginal physical product (MPP) of Labor

• marginal revenue product (MRP)

• minimum wage

• strike

• substitution effect

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