Giant labour market powerpoint

Labour markets

2 parts 1. supply, demand and wage determination

2. Labour market failure

Work vs Leisure

• An alternative to work is leisure time. For each hour an individual works there is an OPPORTUNITY COST

• If an hour of leisure time is chosen, the WAGE is the OPPORTUNITY foregone

PART 1

DEMAND, SUPPLY AND WAGE DETERMINATION

Supply of labour• The total number of hours that labour is willing and able to supply at a

given wage rate.And• The number of workers willing and able to work in a given occupation or

industry for a given wage.

wage

Hours/quantity

The labour supply curve

• The labour supply curve for any industry or occupation will be upward sloping because

• as wages rise, other workers enter this industry attracted by the incentive of higher rewards.

• They may have moved from other industries or they may not have previously held a job, such as housewives or the unemployed.

• The extent to which a rise in the wage or salary in an occupation increases labour supply depends on the elasticity of labour supply.

Backward sloping labour supply curve!

• In the short run the individual’s supply curve may be backward sloping because of the income and substitution effects

Income effect

• The income effect of a wage rise is to:

– Reduce the number of hours people work

……because as the wage rate rises, the worker buys more goods and services including leisure. They have enough money so if they can earn the same for doing fewer hours they will.

Substitution effect

• The substitution effect of a wage rise is to

Increase the number of hours people work

……because as the wage rate rises, the worker gains more from working and increases the opportunity cost of leisure so the worker selects to work more hours. I.e. As the wage rate rises, more labour is supplied to earn more money.

If the wage rate is low, do you think there will be more of an income effect or a substitution effect and why?

• At a low wage rate there is more likely to be a substitution effect as working more hours will increase a worker’s living standards

• Once the wage rate has reached a certain level, the income effect may outweigh the substitution effect and an individual will buy more leisure

Q What is the problem with the income and substitution effect theory in reality?

• Many workers are unable to alter the number of hours they work in their main jobs.

• They have a fixed contract

Supply in the long run

• In the long run people are able to change their occupations - the supply of labour is influenced by the net advantages of the job.

This means the• Pecuniary (financial) and• Non pecuniary (non financial) factors

Pecuniary factors

• Wage rate• Opportunity to work overtime• Possibility of bonuses

Non-pecuniary factors

• Convenience and flexibility of hours• Status• Promotion chances• Location (flexibility)• Qualifications and skills• Job security• Pleasantness of the job

Non-pecuniary factors cont

• Holidays • Perks and fringe benefits• Quantity and quality of training on offer• Recent performance of the firm

The elasticity of supply of labour

• The extent to which the supply of labour changes as a result of a change in the wage rate is measure by PES of labour

% change in Q of labour supplied% change in wage rate

Influences n PES of labour

qualifications and skills required• Supply of skilled workers is more inelastic than the

supply of unskilled workers e.g. the supply of vets is more inelastic than the supply of shop assistants

the length of training• A long period may discourage people from the

occupation. It will take some time for people to qualify even if the wage rate rises. If it falls, people who are a long way into their training may not leave

Influences on PES of labour

the immobility of labour• Depends on how easy it is for workers to switch jobs

(occupational mobility) or to move areas (geographical mobility). Mobility means more elastic supply.

the time period• Over a longer period of time, labour supply becomes more

elastic. In the short run, the wage rate can rise but with little effect on the labour supply

How useful are these explanations?

• Doctor• McDonald’s worker• Economist• Solicitor• Nurse• Teacher• Firefighter

Summary – supply of labour

• The supply of labour is upward sloping – the higher the wage, the more labour is supplied

• In the short run it may be backward sloping owing to income and substitution effects

• In the long run it is determined by the net advantages of the job (pec and non pec)

• It can be elastic or inelastic depending on quals and skills required, length of training, mobility of labour and time.

Demand for labour• In the recession, the UK housing market experienced a

downturn. Housing projects were delayed and scaled down existing sites.

• What is most likely to have happened to the employment of plasterers and bricklayers? – (they will experience lower demand for their services)

• Demand for labour is DERIVED (demand for one depends on demand for another)

Factors influencing demand for labour

• Demand and expected future demand for a productThe expected revenue from increasing/decreasing production can change demand for labour

• ProductivityThe higher the output per worker, the more attractive labour is as a resource

• Wage rateIf the wage rate rises about productivity, costs rise and could contract demand for labour

Factors influencing demand for labour

• Complementary labour costsA change in any other costs associated with labour e.g. National insurance contributions could change the demand for labour

• The price of other factors of productionWhen other factors of prod. change demand for labour can change e.g. If capital becomes cheaper, workers could be replaced by machines

Question

• Why is demand for migrant workers still high despite the recession?

• Demand for firm’s products means labour still needed?

• Skills shortages in the UK?• Migrant workers more productive?• Cheaper?• More flexible about hours, working conditions etc?

Marginal revenue product of labour – a theory about demand for labour and about the price of labour

• MRP theory states that demand for labour depends upon 2 things – Productivity of labour– the demand for the good they produce (which

determines price)

MRP Calculation

• MPP (marginal physical product)

• Marginal revenue (this is the price of the product in perfect competition)

• MRP of labour = MPP x Price

Marginal Revenue Product Theory:

MRP is important in determining wages.

• Workers with higher productivity will tend to get higher wages. Also, workers who help produce profitable goods will get higher salaries. For example, lawyers and professional footballers get high salaries because the marginal revenue of their goods are high

Criticisms of MRP theory• it can be difficult to determine the MRP of workers, for

example, many in the service sector do not produce a tangible output e.g. nurses and teachers

• It assumes that workers are homogenous – they are not, they have differing abilities and productivities

• It ignores that fact that some businesses have monopsony power and can dictate a lower wage rate than MRP suggests

• It assumes that workers are geog and occ mobile and that the supply of labour is perfectly elastic - in reality it is not

Elasticity of demand for labour

% change in quantity of labour demanded% change in the wage rate

inelastic

elastic

Factors affecting elasticity of demand for labour

1. The proportion of labour costs in the total costs of a business: When a businesses’ labour expenses are a high proportion of total costs, labour demand can be expected to be more elastic than a business or industry where fixed costs of capital are the dominant business expense

2. The ease and cost of factor substitution: The demand for labour tends to be more elastic when labour and capital are easily substitutable. This depends on the nature of the production process, the added “human” value that the labour input provides (particularly in service industries) and the flexibility of the labour market (for example the ease and cost of hiring & firing labour is influenced by existing employment laws). When labour is considered a necessity in the production process, the demand will be inelastic in responsive to wage changes. Think about the difference between a car manufacturer and a hotel

Factors affecting elasticity of demand for labour - cont

3. The price elasticity of demand for the final output produced by a business: If a firm is operating in a highly competitive market where final demand for the product is price elastic, they may have little power to pass on higher wage costs to consumers through a higher price, the demand for labour may therefore be more elastic as a consequence

4. The time period under consideration: In the short run, at least one factor of production is assumed to be fixed so the demand for labour as an input will be more inelastic compared to the long run when a business has a much greater opportunity to vary the factor mix between labour and capital

Summary – demand for labour

• Demand for labour is DERIVED• Factors that affect it are: demand for the product,

productivity, wage rate, complementary labour costs • MRP is a theory of demand for labour that depends

on productivity – the more productive a worker, the greater the MRP

• Elasticity of demand for labour depends on: Ease of factor substitution, Time, PED for the product (final output) and the proportion of labour costs to total costs

Wage determination

• Supply and demand interact to determine the wage rate

Demand and supply could be elastic e.g. cleaners, fast food worker (lower wage rate)

Demand and supply could be inelastic e.g. brain surgeons, barristers (higher wage rate)

Wage determination 2

• MRP(L) also explains the wage rate

• A worker is paid according to his/her MRP. A barrister would have a higher MRP than a cleaner therefore would be paid a higher wage.

• As the MRP of a worker increases, they can be paid a higher wage

Wage differentials• Why are there differences between the wages earned in

alternative occupations• This occurs because of • Skill levels• Length of time to train• Demand for labour (PED, substitutes)• Public opinion• Government policy• Relative bargaining strength (trade union)• MRP• OTHER FACTORS FOLLOW IN THE NEXT SLIDES

Male vs Female

Male (paid more on average)• More women work part time• Gap narrowing• MRP of women is much lower (average)• Historically men better qualified• MRP lower as women disproportionately employed in

low paid jobs that generate low marginal revenue• Women leave the labour market to have children and lose

out on promotional chances• Discrimination

Skilled vs Unskilled

Skilled (paid more)• Demand is higher and supply is lower• MRP higher as output is higher• Higher level of human capital • Higher education and training = productivity• Difficult to substitute with machines

Part time vs Full time

Part time (lower paid)• Supply high relative to demand• Productivity lower as they receive less training• Higher proportion are women• Only a small number in a trade union

Ethnic minorities

Ethnic minorities (lower paid on average)• Discrimination• High proportion of Asians working in catering

which is low paid• Qualifications are lower particularly in women

Economic Rent and Transfer Earnings

• A person stays in a job depending on the economic rent and transfer earnings

• Transfer earnings = the minimum payment needed to keep a worker in work (min payment needed to keep a factor of production in its present use)

• Economic rent = the payment to the factor (worker) over and above its transfer earnings in the long run

diagram

• Transfer earnings is the minimum wage you would require for doing a job.Economic rent is the different between what you get paid and what you would do the job for.

The amount of transfer earnings and economic rent depends on the elasticity of supply

Summary wage determination

Wages are determined in a competitive market through:– Supply and demand (note the elasticity can be

important)– MRP of labour– Because of pay differentials– Because of economic rent and transfer earnings

Part 2

Labour market failure

Labour Market Failure

Is caused by:1. Monopsony power2. Trade Union power3. Imperfect information4. Skill shortages5. Economic inactivity6. Unemployment7. Discrimination8. Segmented labour markets9. Geographical and occupational immobility of labour

1.Monopsony• A monopsony producer has significant buying power in the labour market when

seeking to employ extra workers. A monopsony employer may use their buying-power to drive down wage rates. The market fails if this is the case

The marginal cost of employing one more worker will be higher than the average cost because to employ one extra worker the firm has to pay more and increase the wages of all workers.

To maximise the level of profit the firm employs Q2 of workers where MC = MRP

The firm only has to pay a wage of W2. This is less than the competitive wage

2. Trade Unions

• Trade unions are organisations that represent people at work.

• They can put pressure on firms for improved pay and conditions and higher pay. They can:– Restrict the supply of labour– Strike/stop/disrupt production

• This causes labour market failure (see page 18 of revision booklet for an evaluation of their use)

How do they work?They push up wages to W2 which is above the equilibrium and could cause unemployment between Q2 and Q3

HOWEVER – if the employer is a monopsony they could actually increase employment as at the higher wage, more people would be willing to supply their labour

The wage is at W2 but the union could bargain for W1 or W3. At W3 more people could be employed but at W3 no extra workers would want to work but unemployment would not be made worse

Other causes of labour market failure

3. Imperfect informationWorkers may not have the information they need to get a job or a better job - Employers may not be able to afford to advertise to all potential employees so don’t get the best employees – solution – job centres, national databases of jobs

Other causes of labour market failure

4. Skill shortagesOccur when firms struggle to recruit people with the right skills – may have to bid up wages = increased costs. Short-termist attitude towards training? Solutions – education and training, immigration

Other causes of labour market failure

5. Economic inactivity• People who are not in the workforce (actively

seeking or in a job). Some economically inactive e.g. students will provide a long term benefit. Others could work and represent a waste of resources. Solutions – cut benefits, provide training, minimum wage as an incentive to work

Other causes of labour market failure

6. UnemploymentUnemployment means some labour markets are not clearingThose willing and able to work cannot find a jobCauses- cyclical (lack of aggregate demand)Voluntary, frictional and structural

7. Discrimination

Could be caused by several factors including:Personal prejudiceImperfect information – employers do not know

how productive a worker may be so may avoid employing for e.g. over 50s as they may wrongly believe they will be less productive than younger workers

Solutions – education, training, information, laws

8. Segmented labour markets

• There are barriers that prevent workers moving freely between occupations

• Some barriers are good e.g. taxi drivers requiring a driving licence and Surgeons requiring skills and qualifications

• Others are unnecessary and have been introduced to push up wages and to keep groups out

9. Geographical and occupational immobility of labour

Mobility = the ability to move from one sector of employment to another

Changing occupation (occupational)Moving to work in another area (geographical)

A lack of labour mobility is the cause of structural unemployment (mismatches)

Mobility of labour

• Occupational immobility is a result of a skills shortage

Effects• Low skills = low wages• Firms limited to lower profits/cannot achieve

their objectives

Mobility of labour

• Inflation and unemployment (because of skills mismatch )

• - there is always a small amount of unemployment even if the market is in equilibrium. – To solve this AD could be increases but this would lead to

inflation (higher costs = higher prices). The lowest level of unemployment that keeps inflation stable is called the non accelerating inflation rate of unemployment (NAIRU)

• Limitation on competitiveness• Inequality

Geographical immobility

• Lack of information• House prices and structure of housing (renting

vs buying)• Family and social ties

Question

• 4 (a) With the use of examples, explain what is meant by labour market failure. [15]

• (b) “Government attempts to correct market failure by intervening in the labour market are likely to cause more problems than they solve.” Discuss this view. [20]

• June 2009

Labour market flexibility – (solves market failure)

What is it (different types of)• Where the supply of labour is responsive to

changes in the demand for labour.• Labour mobility (occ and geog)• Flexible working patterns (part time, variable

hours, shift work, temp contracts, home working)• Wage flexibility - wages should move both

upwards and downwards in response to changes in supply demand

Labour market flexibility

• Methods to achieve it• training and education• Cut income tax and UE benefits• Link UE benefit to search for employment• Remove employment protection legislation• (Thatcher did this in the 80s but Labour Govt

signed up to the EU social charter in 1997 so had to re-introduce more protection)

Implications of it –

• UK more flexible as govt has removed restrictions on hiring and firing. USA has lower protection but other EU has more

• Widened participation (i.e. more women in the workforce as a result of more part time opportunities

• Less job security – more frictional unemployment but greater employment overall.

• Greater competitiveness

Evaluation

• Look at the figures in your hand out – is it better or worse for the UK economy to have a flexible workforce.

Why and how does the government intervene in the labour market?

• Employment • Information provision• Regional policy• Training and education • NMW legislation• Discrimination legislation• TU legislation

PENSIONS

Explain why there is a ‘Pensions Crisis’.The Pensions Crisis has come about for various reasons • increasing life expectancy, • early retirement schemes draining pension funds, • poor performance of certain funds, • employers and employees not paying sufficient

contributions. • The crisis is that many funds, particular private sector

ones, will not be in a position to pay out what is expected in the near future

Discuss the extent to which this Pensions Crisis might impact on the UK labour market and the economy as a whole.

• The most likely impact on the labour market is that the normal retirement age for male and female workers will increase.

• A tightening up on early retirements and similar concessions that are currently given by pension funds. Consequently, the typical age of workers will increase – some may be rather disillusioned.

• The impact on the economy is that government intervention may be needed in the short term to bale out pension funds.

• There are also implications for the funding of the State Pension and other public services.

• Longer term, the economy may become more productive due to often well qualified people remaining in the labour market.

• Unqualified labour may find it more difficult to obtain work and impact on the rates of direct taxation for those in work.

Immigration

Advantages• An expansion of the labour supply • Reduced pressure on wage inflation• Aggregate demand effects- economic

migrants are likely to earn more than they spend contributing to the growth of the local or regional economy

Immigration

The costs of migration • Depressing the real wages of domestic workers • Doubts about productivity effect: Many immigrants,

especially those from poorer countries, have a low educational level and are more likely to be unemployed or economically inactive than the domestic population.

• Increased pressure on the welfare state (benefits, education, housing and health)

• Unemployment concerns• Increased pressure on scarce resources: (e.g. housing)

EU Directives

• EU directives (laws) have to be made into UK law within a set time period e.g. 2 years

• The UK has the least protection for workers in Europe whereas EU directives tend to help protect workers – e.g. the NMW and maximum working week came from EU directives. Recently the parental leave directive was made UK law – evaluate the effects on the labour market (flexibility in particular)

Poverty and inequality

• Represents about market failure as this shouldn’t happen if the market works efficiently – the wage would be at a level that is enough to live on and everyone would be in a job (this doesn’t happen in reality)

• Absolute poverty - The inability to purchase the basic necessities of life e.g. food, shelter, clothing

• Relative poverty (UK) - A measure of households in one country where income is behind the average– The widely accepted definition of poverty is having an income

which is less than 60% of the national average

What causes poverty?

• Unemployment• Low wages• Sickness and disability• Old age• Poverty trap• Bing a lone parent• Reluctance to claim benefits

What are the effects of poverty?

• Low life expectancy• Poor health• Lower education• Alienation from society• Burden on government/reduction in

productivity

Measuring relative poverty• (1) The Lorenz Curve – a diagram to illustrate income

distribution

• (2) The Gini-coefficient - a calculation based on the lorenz curve to compare income inequality. A value between 0 and 1. The closer to 1 the more unequal

• (3) The percentage of households living below a given percentage of median incomes (60% in UK)

• Most measures of relative poverty concentrate on income rather than wealth

Causes of income inequality• Main cause: The disparity in wages and earnings growth in different jobs and industries

– Huge rises in earnings for the better off– Slower growth of pay for people in low-paid jobs

• Welfare: – Falling relative incomes for those dependent on state welfare benefits – whose value rises

each year in line with prices rather than incomes• Structural / long-term unemployment

– E.g. a high level of workless households (the “economically inactive”) where no one in the household is in paid work

• Low paid jobs:– A long term shift towards part-time service sector employment – often relatively low paid

work with little or no trade union protection• Taxation: Less progressive tax system

– Cuts in the higher rates of income tax (40%)• Inequalities in wealth also create income inequalities

– (e.g. interest from savings, dividends from shares, income from private occupational pensions)

Government interventions

A Tax• Increasing progressive taxes such as the higher

rate of income tax from 40% to 50% will take more income from those on high income levels. This enables cuts in regressive taxes and increased benefits which help increase the income of the poor.

Government interventionsB. increase benefits to the poor

Advantages of means tested benefits: • They allow money to be targeted to those who

need it most. e.g family tax credit or pension credit.

• It is cheaper than universal benefits and reduces the burden on the tax payer

However means tested benefits are often unpopular because people are stigmatised as being poor.

• Also it may create a disincentive to earn a higher wage, because if you do get a higher paid job you will lose at least some of your benefits and pay more tax. This is known as “the benefit trap” or the “poverty trap”

• Some relatively poor may fall just outside the qualifying limit.

• Also not everyone entitled to means tested benefit will collect them because of ignorance or difficulties in applying.

• The government used to prefer universal benefits because it avoided the above problem, and people feel if they contribute towards taxes they deserve their benefits regardless of their wealth

Government interventionsC. Minimum Wage

Since the introduction of the NMW many low paid workers have seen an increase in the hourly wage as firms are obliged to pay workers the statutory minimum wage. To some extent this has helped reduce relative poverty, as the lowest paid workers have seen a significant increase in their weekly income. This is more prevalent in the North where wages tended to be lower; fewer jobs in the south have been affected by the NMW.

A concern about the NMW is that it may cause unemployment. An increase in the NMW to above the equilibrium will lead to real wage unemployment of Q3 –Q2.

Evaluation of NMW• The advantages of a national

minimum wage:• Greater equity will be achieved, and

the distribution of income between the high paid and the low pay may be narrowed.

• Poverty may be reduced as the low paid gain more income and the unemployed may be encouraged to join the labour market. In this case the higher wage is an incentive for individuals to supply their labour.

• Less worker exploitation by labour market monopsonists, who are single employers is able to pay below the market equilibrium.

• The disadvantages of a national minimum wage:

• A high minimum wage can cause price inflation as firms pass on the higher wages in higher prices.

• Falling employment, as demand contracts, and rising unemployment as supply extends.

• The competitiveness of UK goods abroad can suffer compared with low wage economies, such as China and India.

• Inward investment may be deterred, as foreign investors will look to avoid high wage economies.

• The labour market may become inflexible in response to changes in the rest of the economy.

Productivity etc

• Productivity – the output per worker employed• Unit labour cost – cost of labour/output

• Business owners compare unit labour costs to measure productivity. If the unit labour cost decreased over a period of time, productivity increased.

Possible analyse questions

1. Analyse the factors that determine the supply of labour in the short run and the long run

2. Analyse the factors that determine elasticity of supply for labour

3. Analyse why premiership footballers earn more than nurses

4. Analyse 2 causes of labour market failure.5. Analyse the reasons for differences in economic rent

and transfer earnings6. Analyse the reasons for pay differentials