Bahria a2 economics labor markts

Multipliers in 3- sector economy
• Consumption multiplier
• Investment multiplier
• Gov sending multiplier
• Tax multiplier
• Balanced budget multiplier

3) Govt spending multiplier
• This would be similar to investment multiplier in 2 sector economy with the only
difference of an additional withdrawal i.e. Tax
• As expenditure multiplier is
•
• K= Y/Ae = Y/J = 1/1-MPC = 1/MPS+MPT
•
• Therefore govt spending multiplier would be
•
• Kg = Y/G = 1/1-MPC out of natonal income
•
• If MPC = 0.6
• MPS = 0.2
• MPT = 0.2
•
• Then?

Rounds G Y C S T
1 1000 1000 600 200 200
2 600 360 120 120
3 360 216 72 72
4 216 - - -
- - - - -
Total 1000 25,000 1500 500 500
-140-
K= 1/ (1-MPC) = 1/(1-0.6) = 2.5
Y = K* G = 2.5* 1000= 2500

Explanation of above table diagrams to similar as
we explained it in 2-Sector economy

4) TAX MULTIPLIER
• A change in tax will have a multiple effect on
national income & this process will be known as
tax multiplier.
• Tax multiplier is smaller than the expenditure
multiplier (i.e. consumption, investment, govt
spending or export multiplier) by a factor equal to
MPC.
•
• TAX MULTIPLIER = MPC * Expenditure Multiplier.

4) TAX MULTIPLIER
•
• The reason the tax multiplier is smaller than the
expenditure multiplier is straightforward. When
government spends $1 on G, that $1 gets spent
directly on GDP. On the other hand, when
government hits taxes by a dollar, only part of
that dollar is spent on C, while a fraction of that
$1 Lax cut is saved. The difference in the
responses to a dollar of G and to a dollar of T is
enough to lower the tax multiplier below the
expenditure multiplier.

5) Balanced Budget Multiplier
• It can be argued that the effect of exactly equal aggregate changes
in taxes and government expenditure (T = G) is such that, because
of multiplier effects, a new equilibrium will be reached when
national income has risen by the amount of the original change in
government 'expenditure (y= G). Suppose that we have an
economy with a constant propensity to withdraw (s + t) of 0-2. Now
suppose the government increases its purchase of goods and
services by £1000 and increase income tax by £1000. The effect of
the increased spending sets up a multiplier sequence the value of
which will be
• Y =G – 1/ s + t
• Where G = the value of the extra purchase of goods and services by
government and s + t (the propensity to withdraw) remains
constant at 0.9. We would therefore obtain:

• Y= £1000 *1/0.2
• = £5000
• C = MPC * Y
• = 0.8 * 1000
• 800
• However, when we consider the effect of increased
taxation we must consider that 0.2 of E1000 would have
been withdrawn from the circular flow anyway and that
therefore the value of the multiplier will be:
• YT=C x 1/ s + t
• 800 x 1/0-2
• = — £4000

• Therefore the combined effect of these
changes is:
• Y= £5000 — f4000 = £1000. We can therefore
see that the change in income is equal to the
original change in government expenditure.
The elect does not work out as simply as
suggested here, but it is important to realize
that an apparently balanced budget does not
have a neutral effect upon the economy.

Modifying factors
• The balanced budget hypothesis and the other
calculations we have looked at in this section are all
subject to modification when we come to compute
their actual value in the economy. Some of the factors
which cause these modifications are listed below.
• a) Different MPCs. Different sectors of the community
(the very rich, old-age pensioners. etc.) will have
different propensities to consume. Thus the type of
taxes and the type of government expenditure
undertaken .will have differing effects. For example,
increased taxes will make little difference to the
consumption expenditure of the rich but will
significantly affect the spending of the poor,

Modifying factors
• b) Progressive taxes, Because of the
progressive nature of taxation, any .rise in
income Will tend to increase the proportion
paid in tax and vice versa. This therefore
modifies the multiplier. Q.
• c) Inflation. Inflation and the resulting fiscal
drag tend to decrease the size of the
multiplier

Modifying factors
• d) Transfer payments. Money spent on transfer'
payments is usually not treated as part of G.
However, since most transfer payments are made
to lower-income groups and since lower. Income
groups have high MPCs, the effect of increased
transfer payments is to increase the value of the
MPC and therefore the value of the multiplier.
• The balanced budget multiplier states that an
increase:: government spending plus an equal
increase In taxes loth in higher output

• Firm A is earning supernormal profits of Area
P0GM. Firm have a strong incentive to chat and
sell an output beyond its quota up to the point
where P=MC at ‘q’. Firm can earn “GKJH” extra
profit at the expense of “LMNK” which is for less
than its gain.
• However, cheating by one firm will reduce the
sales and profits of its other members of cartel
and they also start violation of cartel agreement
eventually resulting into break-down of cartel and
even start of price war among the firms.

STRENGHT OF COLLUSION (CARTEL &
LEADERSHP)
• It will be easier for firms to collude if the
following conditions apply:
• 1) There are only very few firms, all well known to
each other.
• 2) They are open with each other about costs and
production methods.
• 3) They have similar production methods and
average costs, and are thus likely to want to
change prices at the same time and by the same
percentage

LEADERSHP)
• 4) They produce similar products and can thus
more easily reach agreements on price?
• 5) There is a dominant firm.
• 6) There are significant barriers to entry and
thus there Is little fear of disruption by new
firms.

LEADERSHP)
• 7) The market is stable. If an industry demand or
production costs fluctuate wildly. it will be
difficult to make agreements, partly due to
difficulties In predicting and partly because
agreements may frequently have to be amended.
There is a particular problem In a declining
market where firms may be tempted to undercut
each other's price In order to maintain their sales.
• 9) There are no government measures to curb
collusion

BARRIERS TO COLLUSION
• Demand and Cost Differences
• When oligopolists face different costs .and demand curves, it is
difficult for them to agree on a price. This is particularly the case in
industries where products are differentiated and change frequently.
Even with highly standardized products, firms usually have
somewhat different market shares and operate with differing
degrees of productive efficiency. Thus it is unlikely chat even
homogeneous oligopolists would have the same demand and cost
curves.
• In either case, differences in costs and demand mean that the profit
maximizing price will differ among firms; no single price will be
readily accept. able to all, as-we assumed was true In Figure 25.5 So
price collusion depends on compromises and con-cessions that are
not always easy to obtain and hence act as an obstacle to collusion.

• Potential Entry.
• The greater prices and pro fits that result
from collusion may attract new entrants,
including foreign firms. Since that would
increase market supply and reduce prices and
profits, successful collusion requires that
colluding oligopolists block the entry of new
producers.

• Cheating
• As the game-theory model makes clear. there is a temptation for
Collusive oligopolistic to engage in secret price cutting to increase
sales and profits. The difficulty with such Cheating is that buyers
who are paying a high price for a product to become aware of the
lower-priced sales and demand similar treatment. Or buyers
receiving a price concession from one producer may use the
concession as a wedge to get even larger price concession a rival
producer. Buyers' attempts to play Producers against one another
may precipitate Price wars among the producers. Although secret
price concessions are potentially profitable, they threaten collusive
oligopolies over time. Collusion is more likely to succeed when
cheating is easy to detect and punish. Then the conspirators are less
likely to the price agreement.

• Legal obstacles
• Antitrust Law US antitrust laws prohibit cartels
and price-fixing collusion. So less obvious
means of price control have evolved in this
country.

• Number of Firms
• Other things equal, the larger the number of firms, the
more difficult it is to create a cartel or some other
fount of price collusion. Agreement on price by three
or four producers that control an entire market may be
relatively easy to accomplish. But such agreement is
more difficult to achieve where there arc, nay, 10 firms,
each with, roughly 10 percent of the market, or where
the Big Three have 70 percent of the market while a
competitive fringe of 8 or 10 smaller firms battles for
he remainder.

• Recession
• Long-lasting recession usually serves as an enemy of
collusion, because slumping markets increase average total
cost. In technical terms, as the oligopolists' demand and
marginal-revenue curves shift to the left in Figure 25.5- in
response to a recession, each firm moves leftward and up-
ward to a higher operating point on its average_ total-cost
curve. Firms find they have substantial excess production
capacity, sales are down; unit costs are up, and profits are
being squeezed. Under such conditions, businesses may
feel they can avoid serious profit reductions (or even
losses) by cut-ting price and thus gaining sales at the
expense of rivals

DUPOLY
• Maximize its profits that single price will not
benefit all firms equally. To reduce the risk of a
price war, the price leader must take the situation
of its followers into considerations when initiating
price changes for the industry as a whole.
• Maximize its profits that single price will not
benefit all firms equally. To reduce the risk of a
price war, the price leader must take the situation
of its followers into considerations when initiating
price changes for the industry as a whole.

• If leader assumes that rivals will simply follow
it by making exactly the same percentage
price changes up or down, then a simple
model can be constructed. This is illustrated in
fig 410. The leader assumes that it will
maintain a constant market share (say 50%)

• The leader will maximize profits where its
marginal revenue Is equal to its marginal cost. It
knows its current position on its demand curve
(say, point a). it then estimates how responsive its
demand will be to industry-wide price changes
and thus constructs its demand and MR curves
on that basis. It then chooses to produce Q, at a
price of P, at point 1 on its demand curve (where
MC = MR). Other firms then follow that price.
Total market demand will be QI, with followers
supplying that portion of the market not supplied
by the leader: namely, Qt — Qt.

• There is one problem with this model. That Is
the assumption that the followers wilt want to
maintain a constant market share. it is
possible. that if the leader raises its price, the
followers may want to supply more at this
new price. On the other hand, the followers
may decide merely to maintain their market
share for fear of invoking retaliation from the
leader, in the form of price cuts or an
aggressive advertising campaign.

Other forms of tacit collusion
• An alternative to having established leader is for
there to be an established set of simple 'rules of
thumb' that everyone follows. One such example
Is average cost Pricing. Here producers. Instead of
equating MC and MR, simply add a certain
percentage for profit on top of average costs.
Thus, if average costs rise by 10 per cent, Prices
will automatically be raised by 10 per cent. This is
a particularly useful rule o thumb in times of
inflation, when all firms will be expecting similar
cost increases.

Other forms of tacit collusion
• Another rule of thumb is to have certain price
benchmarks. Thus clothes may sell £9.95, £14.95,
£19.95, etc. (but not £12.31, £16.42 or £20.04). If
costs rise, then simply raise their price to the next
benchmark, knowing that other firms will also do
the same.
• Rules of thumb can also be applied to advertising
(e.g. you do not criticize other firms products,
only praise your own); or to the design of the
product (e.g. light-manufacturers tacitly agreeing
not 'to bring out. everlasting light bulb).

Oligopoly and Efficiency.
• Is oligopoly, then, an efficient market structure
from society's standpoint? How do the price
and output ci decisions of the oligopolistic
measure up to the triple: equality P = MC =
minimum ATC that occurs in pure
competition?

Productive and AL locative Efficiency
• Many economists believe that the outcome of
some oligopolistic markets is approximately as
shown in Figure. This view is bolstered by
evidence that many oligopolists sustain: sizable
economic profit year after year. In that case, the
oligopolies production occurs where price
exceeds marginal cost and average total cost.
Moreover, production is .below the output at
which average total cost is minimized. In this
view, neither productive efficiency (P = minimum
ATC) nor AL locative efficiency (P = MC) is likely to
occur under oligopoly

• A few observers assert that oligopoly is actually
less desirable than pure monopoly, because
govern-, meat usually regulates pure monopoly
to guard against abuses of monopoly Power.
• Informal collusion among oligopolists may yield
price and output results similar to those under
pure monopoly yet give the outward appearance
of com-petition involving independent firms.
•

Oligopoly and the consumer
• Oligopolists are likely to engage in much more extensive
advertising than a monopolist. These problems will be less
severe, however, if oligopolists do not collude, if there is
some degree of price competition and if barriers to entry
are weak. Also the power of oligopolistic in certain markets
may do so-_i.e. extent be offset if they sell their product to
other powerful firms. Thus, oligopolistic producers of baked
ber ns or soap powder sell a large proportion of their
output to giant super markets which can use their market
power to keep down the price at which they purchase
these: products. This phenomenon is known as
countervailing power. Ins 'me respects, oligopoly gives
advantages to society ever other markets.

• Oligopolists. Like monopolists, can use part of
their supernormal profit for research and
development. Unlike monopolists, however,
oligopolists will have a considerable incentive to
do so. If the product design is improved, this may
allow the firm to capture a larger share of the
market, and it may be some time before rivals
can respond with a similarly improved product. If,
in addition, costs are reduced by technological
improvement, the resulting higher profits will
enable the firm to withstand better a price should
one break out.

• Non-price competition through product
differentiation may result in greater choice for
the consumer. Take the case of stereo
equipment. Non-price competition has led to
a huge range of different products of many
different specifications, each meeting the
specific requirements of different consumers.
it is difficult to draw any general con-elusions,
since oligopolies differ so much in a their
performance.

Mergers and Acquisitions-
• A firm can grow in two ways. First, building
new plants by ploughing back retained
earnings and/or borrowing capital funds from
the market. Secondly, acquiring the assets of
another firm. This second way is growth by
acquisition.

• The word merger is the. Name that we give to the
process of combination of a number of !inns (in
most cases, two firms) into a single corporation.
The growth by merger mainly occurs through
acquisition. The merger serves the objectives of
the cartel without attending the problems of a
cartel. Thus, merger is essentially a collusive '
device. If the merger leaves the Cost curves of the
firms unaffected, there is no fundamental
difference between a cartel and an equivalent
manger.

• There are three types of mergers: horizontal merger,
vertical merger and conglomerate merger.
•
• Horizontal merger involves the combination of two firm’s
in. the same 'industry. Thus, two competitors are combined
into a single corporation. For example, a soft-drinks
company can acquire another sort drinks company.
•
• Vertical merger. Involves combination of two firms at
different stages of production. For example, firm A can buy
firm B which is the supplier of .an important input to firm
A.

• Conglomerate merger involves combination of two
unrelated business areas. For example, a cigarette company
can buy a hotel business. The firms try to diversify their
business areas through conglomerate merger. In case of
horizontal and vertical mergers, the acquiring firm
increases its presence in the same line of business by
acquiring either the competitor firms or the firms supplying
key inputs. This tends to promote Industry wise
concentration. In case of conglomerate merger, a firm
increases its presence in non-competing lines of business.
This tends to promote country-wise, cross-country-wise, or
even global concentration. The motives for merger are
varied. Some of the important motives are discussed below.
•

• The process of merger increases the market power of
the sellers because less the number of competing firms
higher is the degree of monopoly power. The collusion
can be more easily accomplished if there are fewer
firms in the industry. This is one of the main reasons w
y the proposal 'for merger is often rejected by the
government. For example, Ministry of Finance (MOF)
of the Government of India has recently opposed the.
proposal to merge Madras Refineries Ltd. and Cochin
Refineries Ltd. with the Indian Oil Corporation and
Bharat Petroleum Corporation. The MOF has held that
the merger will lead to monopolistic situation and.
block, competition.

• The merger is an important route through
which individual firms unable in achieve scale
economies can jointly attain the minimum
efficient scale of production.

• . But there is very little empirical evidence of
scale economies following merger.
• The modern-day corporate firms are more
controlled by the senior management cadres
than by the owners. The mergers can be
effectively used to promote the income and the
power of the managers because it had been
amply demonstrated that the salaries of the
senior managers are positively. Associated with
the growth of the firm:.

• If the owner's profit maximization goal is sacrificed to
accommodate the executives' pursuit of growth, actual
profit will fall below the potential level. As a result, the
firm's' share price will fall. The fall in share prices. Will give
incentive to the profit-oriented firms to take over the
errant firm and restore its profitability_ (y). The oligopolists
are not only the sellers but also the buyers. Of different
inputs. The. Merger activity combines the oligopolists into a
single entity and therefore increases the new corporation's
share of purchases in the market for. Inputs. The newly
formed corporation now has a greater market power as a
buyer. This may enable • the corporate buyer to obtain
inputs at lower prices due to bulk purchases.

• The transaction costs (costs other than price
which are incurred in trading goods) are
involved when the firms procure inputs from
the suppliers. Vertical merger can substantially
reduce transaction costs by internalizing the
production activities of the suppliers.

• Conglomerate mergers are often used to spread out
risks. The concentration of resources in a single line of
activity is risky because every business has its good and
bad times. But fortunately, bad years in some sectors
may coexist with good years in other sectors. If
investment is spread out by acquiring different product
lines, then business loss in one line may well be
balanced by profits in other areas. This helps to
smooth out profit fluctuations. Whatever may be the
motive for merger it is clear that mergers tend to
increase the concentration ratio by restricting the'
number of competitors in the market. Some examples
of merger are given below:

• Examples of merger are given below
• 1. BPL group has merged its home appliances business with the
Japanese electronics giant Sanyo in May, 2000. Sanyo acquired 14%
equity in the new entity.
• 2. Indian Seamless Metal Tubes Ltd. and Kalyani Seamless Tubes Ltd:
have merged into a new Corporate entity, known as Indian
Seamless Metal Tubes Ltd. in July, 1999. The merger is expected to
improve scale economies and competitiveness.
• 3. In one of the largest brand acquisitions in recent times, US-based
Sara Lee Corporation took over the entire biscuit business of South
India based Nutrine in 1997. Earlier, Sara Lee took over Godrej's
Good Night, Jet and Kiwi Tik’s major hair care, shoe care and
household brands like Kiwi, Flush, Drainex and Brylcream.

• When looking at the market for labor, it Is
useful to make a similar distinction to that
made in goods markets: the distinction
between perfect and imperfect markets. That
way we can gain a clearer understanding of
the effects of power, or lack of it, in the labor
market. Although In practice few labor
markets are totally perfect, many do at least
approximate to it.

• Wage determination in a perfect market
•
• Assumptions
•
• The assumptions of perfect labor markets are similar to those of
perfect goods markers. The main one is that everyone is a wage
taker, In other words, neither: neither employers nor employees
have any economic power to affect wage rates. This situation is not
uncommon. Small employers are likely to have to pay the 'going
wage rate' to their employees, especially, where the employee is of
a clear category, such as an electrician, a bar worker, a .secretary or
a porter. As far as employees are concerned, being a wage taker
means not being a member of union and therefore not being able
to use collective bargaining to push up the wage rate.

• The other assumptions of a perfect labor
market are as follows:.
• There are no restrictions on the movement of
labor. For examples workers are free to move
to alternative jobs or to areas of the country
where wage rates' are higher. There are no
barriers erected by, say, unions, professional
associations or the government. Of course, it
takes time for workers to.

• Perfect knowledge
• Workers are fully aware of what jobs are
available at what wage rates and with What
conditions of employment. Likewise
employers know what labor is available and
how productive that labor is:

• Homogeneities labor.
• It is usually assumed that, in perfect markets,
workers of a given category are identicil in
terms of productivity. For example,• it Would
be assumed that all bricklayers are equally
skilled motivated,
• Law of diminishing returns operate

• Perfect competition in both products and
labor market
• Wage rates and employment under perfect
competition ate determined by the interaction
of the market demand and supply of labor.
• Supply of labor by a individual worker
• Supply of labor faced by a firm in perfectly
competitive market
• Market industry supply of labor

• SUPPLY CUVE FOR INDIVIDUAL WORKER
• A supply curve shows the quantity that will be
supplied to the market at any given price. For an
individual worker, the quantity supplied is the
number of hours worked over a tune period, such
as a year. Neo-classical theory starts by assuming
that a worker can decide how many hours to
work per week and how many weeks' holiday to
take per year. The price of labor is the wage per
time period (ie. the vage rate).

• The wage rate that determines supply is the real
wage rate (the money or nominal wage rate
divided by the price level). This is because the
worker decides how many .hours to work by
relating it to what the wage will buy. For
instantce, a worker might take a job if a week's
wages of £.300 were to buy a television set, but
she would be likely to turn it down if £3OO were
to only buy a newspaper.. Figure 72.1 shows a
backward bending supply curve for labor.

• Between wages rates 0 and B a rise in real wage
rates will lead to an increase in working hours
supplied. For instance, the worker will offer to
work DF extra hours if real wage rates increase
from A to B . However, a rise in• real wage rates
above OB, for instance from B to C, will lead to a
desire for shorter working hours. To understand
Why this might be the case, consider a part time
factory worker. Initially she is low paid, as arc
nearly all part time workers. . The firm she works
for then doubles her real wage rate. She is likely
to respond to this by wanting to work longer
hours and perhaps become a full time worker.
Further increases in real wage rates t3NDI might
persuade her to work overtime

• However, there are only 24 hours in a day and 365 days in a
year. Eventually • it is likely that increases in wage rates will
make her want to reduce her working week or increase her
holidays. She will value increased leisure time more than
extra money to spend. Put another way, she is choosing to
buy leisure time by forgoing the wages she could otherwise
have earned and the goods she could otherwise have
bought, this is an example of the concept of opportunity
cost. This process can be Seen at work over the past 100
years in the UK. Real wages rates have risen considerably
but hours worked have fallen. The typical Victorian working
week was 60 to 70 hours with few or no holidays. Today,
average hours worked per week for full time workers are
down to about 42 hours with a typical holiday entitlement
of 4 weeks per year. Workers have responded Co increases
in wage rates by supplying less labor.

• . Note that when wage rates increase; workers
are likely to be able to both increase earnings
and reduce hours worked. For instance, if real
wage rates increase by.20 per cent from £10
per hour to £12 per hour, then workers can
cut their hours worked by 10 per cent from 40
hours to 36 hours per week and still see an
increase in earnings from £400 per week (40 x
£10) to £432 per week ,(36 x E12). Real wage
rate increases in the neo-classical model give
workers a choice between increased earnings
or increased leisure time or some combination
of the two:

• However, work is arguably an inferior good.
• • . The higher the income, the fewer hours
individuals will wish to work. For instance, it is
pointless being able to • buy tennis or squash
equipment if you don't have the time to play.
Earning more money has little Use if you can't
take the time off to have a holiday, go to the pub
or go. • shopping. So the income effect of work
tends to be . . . negative for most individuals. The
higher.the income, the • less work and the more
leisure time is demanded.

• INCOME AND SBSTITUION EFFECTS
• For an individual worker, price of work is the cost
he pays for doing work. i.e. leisure sacrifice
• Similarly price or cost he pays for not working
and leisure is the wage he could have by working.
An change in real wage rate will have two effects
for an individual worker. i.e
• Income Effect
• Substitution Effect
•

• Income effect
• Income effect is defined as change in
willingness of a worker to work due to change
in real income, (when his wage changes).

• II) SUBSITUTION EFFEC (SE)
• SE of a wage change may be defined as change in
willingness of worker to work due to relative change in
price of work & leisure.
• An increase in real wage means that reward for work
increases. For instance, a worker is paid $10 per hour
initially. If his wage rises to $12/hour, he has to now
sacrifice hour leisure for $12. Therefore Leisure is now
more expensive relatively, In other words, work is now
relatively cheaper, therefore worker will substitute work for
leisure if the rate of wage increases. This increase in
willingness to work due to a relative cheapness of work is
the substitution effect of a wage increase. S.E. of wage rise
will always be positive

• The backward bending supply occurs because of the interaction of
income and substitution effects. At low levels of income, the
positive substitution effect outweighs the negative income effect of
a wage rise. Hence a rise in pay for these workers leads to an
Increase io the number of hours worked. At higher levels of bloom
the positive substitution effect is likely to be squally matched by the
negative income effect. Wage increases then have neither an
incentive nor a disincentive effect on working hours. But at high
levels of income, the positive substitution effect of a wage increase
is more than offset by the negative income effect. Hence the
worker will choose to work fewer hours... This can be shown in
Figure 723. At wage rates up to °As higher wage rates will lead to
increased hours of work. Between A and B the supply curve is
vertical, showing that increased wages have no effect on hours
worked. Between A and B the negative income effect cancels out
the positive substitution effect as wages rise. Above 0B the supply
curve slopes backward showing that. - The negative income effect
of a wage rise more than offsets its positive substitution effect.

• Although there is general agreement that the supply
curve of labor by single individuals exhibits the
backward-bending 'pattern, economists disagree as to
the shape of the aggregate supply, of labor. Several
writers argue that in the short run the market supply of
skilled labor may have segments with positive and
segments with negative slope. However, in the long run
the supply must have a positive slope, since young
people will, be attracted to the markets where the
wages are high and also older workers may undertake
retraining and change jobs if the wage incentive is
strong enough.

• An industry can increase the number of hours worked by its labor
force in two ways
• • it can Increase the number of hours worked by its existing labor
force;
• •it can recruit new workers- As explained above, a rise in real
wage rates, all other things being equal, may or may not increase
the supply of individual workers in the industry.
• However it is likely to attract new workers into the industry.
• These new workers may be from other industries or they may be
workers who previously did not hold a job, such as house persons
or the unemployed. Therefore the supply curve of /about- for an
industry is likely to be upward sloping, the ability of firms to recruit
new workers outweighing any possible disincentive effect on
existing workers. The higher the industry real wage rate, the more
workers will want to enter that particular Industry,

• Supply of labor by an individual firm in the
perfectly competitive labor market
• Under a perfectly competitive labor market,
there are as many (buyers of labor) so that a
single firm purchases only a small portion of
total labor and is unable to influence the market
wage. Firm can employ as many units of labor as
it needs at a given wage rate. Therefore supply
of labor to a single firm in perfectly competitive
labor market is perfectly elastic.

MRP CURVE
• In the short run at least one of the factors of
production is fixed. Assume that all factors are fixed
except labour..The law of diminishing returns states
that marginal output will start to decline if more and
more units of one variable factor of production are
combined with a given quantity of fixed factors. One
common example is to imagine a plot of land with a
fixed number of tools where extra workers are
employed to cultivate the land. Diminishing returns will
quickly set in and the eleventh worker, for instance, on
a one acre plot of land will contribute less to total
output than the tenth worker.

• This is shown in Table 71.2. Labor is assumed to be a
variable factor of production whilst all other factors are
axed. As extra workers is employed, total output; or,
TOTAL PHYSICAL: PRODUCT increases. However,
MARGINAL PHYSICAL .PRODUCT, the number of extra,
units of output a Worker produces starts to decline
after the employment of the second worker. So,
diminishing marginal returns set in with the third
worker. Assume that the firm is in a perfectly
competitive industry and therefore faces a horizontal,
perfectly elastic demand curve. This means that the
firm can sell any quantity of its product at the same
trice per unit.

• . In Table 71.2, it is assumed that the price of
the product is £10. MARGINAL REVENUE
PRODUCT can then be calculated because it is-
the addition to revenue from the employment
of an extra worker. For instance, the first
worker produces 8 units and so, at a price per
product unit of £10, her marginal revenue
product is ,:10 x S). The marginal revenue
product of the second, worker is £90 (£10 x
the marginal physical product).

• Similar to product market,
• Price of labor = Marginal factor cost of labor
– Average cost of labor
• W = MFC = AFC

Demand of Labor in perfectly
Competitive Labor Market
• Marginal Revenue Product (MR) Theory
• Assumptions of the Theory
• The marginal productivity theory of distribution is
'based on a number of assumptions:
• It assumes that all units of a factors are homogenous
• They can be substituted for cub other;
• That there is Perfect mobility of factors as between
different places and employments;
• That there is perfect competition the factor market and
commodity market;
• That there is full employment or factors and resources;

• That the various units of the different factors-
services are divisible;
• That the entrepreneurs are motivated profit
maximization;
• That the theory isapplicable.in the long-run;
and
• That it is based on the Law of Variable
Proportions

• Explanation;- Measurement of MRP
• Marginal revenue of labour (MRP),
• The marginal revue that the firms gain from
employing one more worker is called the
marginal revenue product of labor (MRP1). The
MRPL is found by multiplying two elements—
the marginal product of labour (MPPl) and the
marginal revenue gained by selling one more
unit of output (MR).
• MRPl = MPPl * MR

• The MPPL is the extra output produced by the last worker.
Thus if the last worker produces 100 tons of output per
week (MPPL), and if the firm earns an extra $2 for each
additional ton sold (MR), then the worker’s MRP is $200.
This extra worker is adding $200 to the firms revenue.
• According to the basic assumption of MRP theory, firms
are operating in perfect competition in labor & product
market, therefore.
• MR = P= AR
• So
• MRP2 = P*MPP2
•

The profit-maximizing level of
employment for a firm

• How many workers should a firm employ in
order to maximize its profits? The firm will
answer this question by weighing up the
costs of employing extra labor against the
benefits. It will use exactly the same
principles as in deciding how much output to
produce. In the goods market, the farm will
maximize profits where the marginal cost of
producing an extra unit of a good equals the
marginal revenue from selling it: MC = MR

• In the labour market, the firm will maximize profits where
the marginal cost of employing an extra worker equals the
marginal revenue that the worker’s output earns for the
firm: MC of labour = MR of labor. The reasoning is simple,
If an extra worker adds more to a firm’s revenue than its
costs, the firm’s profits will increase. It 'will be worth
employing that worker. But as more workers are
employed, diminishing returns to labour will set in. Each
extra will produce less than the previous One, and thus
earn less revenue for the firm. Eventually the marginal
revenue from extra workers will fall to the level of their
marginal cost. At that point, the firm will stop employing
extra workers. There are no additional profits to be
gained.

At a wage rate of ii1r1, Q1 labour is demanded (point a); at 1/412, Q3 is demanded (point ()); at
W3, Q3 is demanded (point c). Thus the MR& curve shows the quantity of labour employed at
each wagd rate. But this is just what the demand curve for labour shows. Thus the MRPL curve
is the • demand curve for labour.

• Its Critisim
• . The marginal productivity theory of distribution has
becn one of the most criticised theories in 'economics
due to ' it’s unrealistic assumption's.
• (I) All Units of a factor are not homogeneous. The
assumption that all units of a factor-service are
homogeneous is unrealistic. We know that efficiency,
of labour differs from worker to worker. Similarly one
piece of land differs from the other in fertility. It is
therefore not correct to assume that the different
factor units of the same. Service is homogeneous. In
fact, heterogeneity and not homogeneity is the rule.
It follows that since no two factor-units are
homogeneous; are non-substitutable for each other.
A textile engineer cannot be put in place of a sugar
technologist.

• The theory assumes perfect mobility of factors
as between different employments and places.
But in reality factors are mostly immobile..
There is no automatic movement of factor unit
from one industry or place to another. The
greater the degree of specialization in an
industry, the less is the faci.tr LI)/ from one-
industry to another. That is why factor units of
same service or even of different services are
not paid equal to marginal productivities in
every occupation and at all places.

• (3) There is no Perfect Competition. The theory
is based on another unrealistic assumption of
perfect competition which is to be found neither
in the factor market nor in the commodity
market. Perfect competition is not a reality but a
myth. Rather imperfect competition or
monopolistic competition is the rule which leads
to the exploitation of factors as they are paid
much below their marginal productivity. Prof.
Chamberin has however applied the marginal
productivity theory to imperfect competition.

• (4) Factors are not Fully Employed. The theory
assumes the existence of full employment in the
economy. Otherwise in case of unemployment,
factor-units will offer their services even at a price
less than their marginal product. This assumption of
full employment makes the theory static. On the
contrary, Keynes has shown that underemployment
rather than full employment is found in an economy
and that total employment depends upon effective
demand in a community. The marginal productivity
theory is at the most applicable to a firm.

• (5) All Factors are not Divisible. The assumption that
factor units are divisible and therefore can be
increased by small quantities does not hold true. It is
not possible to vary an individual, large or lumy
factor. For example, how can the entrepreneur of a
firm be increased or decreased by small units?
Moreover, in the case of a large factory the addition
or subtraction of one factor unit will have practically
no effect on the total productivity. It may be true in
domestic production. Thus the equality between
marginal productivity and price of factors cannot be
brought about by varying their quantities a little less
or more.

• (6) Production is not the Result of one Factor
Alone. Another criticism which follows from
the preceding point is put forth by Taussig
and Devonport that production of a
commodity cannot be attributed to any one
factor, land, labour or capital. Rather it is
always the. result of factors and their units
working together. It is therefore not possible
to calculate the marginal productivity of each
factor-unit separately.

• (7) Profit Motive is not the Main Motive. The
assumes that the entrepreneurs are motivated
by maximization of profits, that is why more
units of a factor-service are employed when the
firm finds the marginal revenue product of the
services is higher than its price.. But as pointed
out by Schumpeter, the entrepreneurial action is
guided by the desire to found a commercial
kingdom, the will to conquer, the joy of creating
and getting things done. It is therefore not true
to say that the entrepreneur is guided by the
profit motive.

• (9) Neglect of Technical Progress.
• The marginal productivity theory fails to throw light on
the determination of relative shares.by, neglecting the
influence of technical change. Prof. Hicks has shown that a
labour. Saving innovation tends to raise the marginal
product of capital relative to that of labour. The opposite
may happen in the case of capital-saving innovation. But
sometimes a technical change requires the use of
cooperating factors in axed proportions, say two workers
for one machine. Even an abundant and cheap labour can-
not induce employers. to employ more than two workers
on that machine. Thus the marginal productivity theory
fails to analyse the problems of technical change:

• Conclusion_ We may conclude that the marginal
productivity theory is not an adequate explanation or
the determination of the pricing of factor-services. It
simply 'states the demand side bribe-factor-pricing
and, therefore, is one-sided. It is worked-under the
restricted assumptions of perfect competition and full
employment. Of resources and is thus unrealistic. It is
static and takes for given that the pride of a factor-
unit must be equal to its marginal revenue
productivity. Thus it fails to explain the'
determination of factor pricing in a dynamic
economy.

Wage Determination in imperfect
markets
• Wage determination under monopsony
• Wage determination under labor market
• Wage determination under bilateral
monopoly

markets
• MONOPSONY
In the real world, many firms have the power to influence wage
rates: they are not wage takers. This Is one of the major types of
labour market 'imperfection'. When a firm is the only employer of
a particular type of labour, this situation Is called a monopsony.
The Post Office is a monopsony employer of postal workers.
Another example is when a factory is the only employer of certain
types of labour in that district. It therefore has local monopsony
power. When there are Just a few employers, this is called
oligopoly.
• Monopolists (and ollgopsonists too) are 'wage setters' not 'wage
takers'. Thus a large employer in a small town may have
considerable power to resist wage Increases or even to force wage
rates down.

markets
• SUPPLY OF LABOR IN MONOPSONY
• A monopsonist firm is a. single buyer of a
particular factor in the market. Since the firm is
the market for the factor in this case, the supply
of factor service to the monopsonist is identical
to its supply to the market. Thus the supply
curve to the firm (AFC) is positively sloping from
left to right upward. The flan can employ more
units of the factor service by offering a higher
price per unit.

• The MFC curve to this AFC curve will also be
sloping upward and will be above the AFC
curve throughout its length. The reason Is
that the wage rate has to be raised to attract
extra workers. The MFC will thus be the new
higher wage paid to the new employee plus
the small rise in the total wages bill for
existing employees: after all, they will be
paid the higher wage too.

markets

markets
• Demand for labor faced by monopoly
•
• Demand for labor of a monopsonist depends over
the behavior of monopsony in product market. If
monopsonist face perfect competition in product
market & price taker then.
• Demand for Labor = MRP2 = P*MPP
• MRP2 for a firm facing perfect competition in product
market will be downward sloping because of law of
diminishing returns.
• MRP = MP*MPP

markets
• MP = Constant
• MPP = Diminishes with increase Labor
• However, if a monopsonist is facing imperfect
competition in product market (i.e. either
monopolistic competition, oligopoly or
monopoly), His MRP curve will slope downward
because of two reasons. One is law of
diminishing returns to variables factor & the
other reason is falling MR with the increase in
output.
• Under imperfect product market MR & AR are

markets
• Profit maximizing output under monopoly

markets
• The profit-maximizing employment of labour
would be at: Qv where MFG= MRPL, The wage
(found from the Act curve) would thus be WI. If
this had been a perfectly competitive labour
market, employment would have been at the
higher level Q2, with the wage rate at the higher
level W2, where W = MRPL. What in effect the
manopsonist is doing; therefore; is forcing the
wage rate down by restricting the number of
workers employed.

BILATERAL MONOPLY
• Trade unions vs. monopsony employers
• Many trade unions operate in factor markets where
there are monopsony employers. A sole seller of labour
(the trade union) faces a sole buyer of labour (the •
monopolist). •
• Economic theory suggests that a trade union will
increase both wages and employment compared to a
factor market where a monopsony employer
negotiates with a large number of individual
employees. Figure 74.2 (a) shows the wage and
employment levels in an industry with a monopsonist
and many individual employees

Employment is OA and the equilibrium
wage rate is OE.
• FGS- Supply curve of labor after union selling
minimum wage of facing monopsony.
• FG => MCl = S in this part

TRADE UNIONS
• A trade union is an organization of workers who combine
together to further their own interests. Within a company
organization, an individual worker is likely to be in a
relatively weak bargaining position compared.to his or her
employer. The employer possesses far greater knowledge
about everything from safety standards to the profitability
of the firm than an individual worker. Moreover, the loss of
an individual worker to a firm is likely to be far less
significant than the loss of his or her job to the employee.
So workers have organized themselves in unions to bargain
collectively. Instead of each-individual worker bargaining
with the firm on a wide range of wage and employment
issues, workers elect or appoint

TRADE UNIONS
• Representatives to bargain on their behalf from an
economic viewpoint, trade unions act as monopoly
suppliers of labor. Trade unions play a very
controversial I role in the economy. Critics argue that
trade unions, by forcing up wages and resisting
changes in working practices create unemployment.
Neo-classical economic theory supports this view,
assuming that factor markets arc perfectly competitive.
However, as will be argued below, lt also suggests that
trade unions increase employment if a trade union
represents workers in a firm which is the sole buyer of
labour.

Unions and market power,
• How can unions influence the determination of
wages, and what might be the con-sequences of
their actions?
• The extent to which unions will succeed in
pushing up wage rates depends on their power
and militancy. It also depends on the power of
firms to resist and on, their ability to pay higher
wages. in particular, the scope for unions to gain
a better. Deal for. Their members depend on the
sort of market in which the employers are
producing.

• Unions facing competitive employers If the employers are
producing under perfect or monopolistic competition,
unions can raise Wage rates only at the expense of
employment. Firms are only earning normal profit. Thus if
unions force up the wage rate, the marginal firms will go
bankrupt and leave the industry. Fewer workers will be
employed: The fall In output will lead to higher prices. This
will enable the remaining firms to pay a higher wage rate.
Figure 5.9 illustrates these effects. If unions force the
wager-rate: up from W1 to Wz, employment will fall from
Q1 to Q2. There will be a surplus of people,(Q3 7 Q2)
wishing to work in this industry for whom no jobs are
available.
•

The union is In a doubly weak position. Not only will jobs be lost,
as a result of forcing up the wage rate, but also there is a danger
that these unemployed people will undercut the union wage,
unless the union can prevent firms from employing non-
unionized labour.

• • Wage rates can be increased without a reduction In the
level of employment only if, as part of the bargain: the
productivity of labour is Increased. This is called a deal. The
MRP curve, productivity and hence the D curve In Figure
5.9, shifts to the right. In a competitive market, then, the
union Is faced with the choice between wages and jobs. Its
actions will thus depend on its objectives. If it wants to
maximize 'employ/new, it will have to content itself with a
wage of WI in Figure 5.9, unless productivity deals can be
negotiated. At WI, Q1 workers will be employed. Above
W1, fewer than (24 workers will be demanded. Below WI,
fewer than Q1 workers will be supplied. If the union is more
concerned with securing a higher wage rate, it may be pre-
pared to push for a wage rate above W1 and accept some
reduction in employment. This is more likely if the
reduction can be achieved through 'natural wastage'. This is
where people retire, or take voluntary redundancy or
simply leave for another.

• Figure 74.2 (b) shows the entry of a trade union to the
industry. Assume that the trade union forces the wage
rate up to OF. This produces a kinked supply curve. The
monopsonist cannot pay a wage lower than OF
because of its union agreement: However, it is free to
pay. Higher wage rates if it wishes to employ more than
05 workers. This produces a kink in the marginal cost of
labour to the firm. Up to OB, the marginal cost of
labour is the same as the union negotiated wage rate.
The employer can hire an extra 'unit of labour at that
wage rate. If it • employs more than OB workers, the
wage rate will rise, resulting in a jump in marginalcost
at OB. The rnonopsonist has a profit incentive to hire
extra so long as the marginal revenue product of
labour, Shown by the demand curve, is greater than
the marginal cost of labour. Hence it will employ OB
workers.

• Why should a monopsonist buy more labour at a
higher wage rate from a union than it would
otherwise? It should be remembered that a firm
bases its decision on how much labour to hire not
on the wage rate (the average cost of labour) but
on the marginal cost of labour. It can be seen
from Figure 74.2 that the marginal cost of
unionized labour is lower between employment
levels A and B than it would have been if labour
had been non-unionized. In the 'former case it is
flat at OF, whilst in the latter it is rising steeply
above OF.

EFFICIENCY OF TRADE UNIONs
• Neo-classical economic theory suggests that
trade unions operating in competitive
industries reduce employment levels and raise
wage rates. If all industries but perfectly
competitive then a trade union in that one
industry would mean that the economy as a
whole was not Pareto efficient

• However, most industries in the UK are
imperfectly competitive. A trade union facing a
monopolist will redress the balance of power in
the industry and lead to a level of employment
and .a wage rate which will be nearer to the free
market price of labour. It could well be that the
presence of a trade union increases economic
efficiency in an imperfectly competitive market.
Hence the effect of trade unions on economic
efficiency depends on the structure of markets in
an economy. A further important argument needs
to be considered: -

• • Some economists have suggested that trade unions raise ,
economic efficiency because they lower costs of
production to the firm.
• , The trade union performs many of the functions of a
Personnel department within a firm. It deals with workers'
problems and obviates the need for the firm to negotiate
pay with each and every worker; More importantly, it can
be a good vehicle for negotiating changes in working
practices. A firm may wish to implement changes which will
lead to less pleasant working conditions for its workers.
Perhaps it wishes to ' • increase the speed of the assembly
line, or force workers to undertake a variety of tasks rather
than just one.

• . It may find it difficult to implement these changes on
a non-unionized workforce because some workers may
take unorganized industrial action or do their best to
disrupt any changes being introduced. A union may
help the firm to persuade workers that changes in
working practices are in their own interest. The union
will usually demand a price for this co-operation -
higher wage rates for its members. But.it still leads to
an increase in economic efficiency because the firm is
able to make higher profits whilst workers receive
higher wage rates. According to this view, trade unions
increase productivity in the economy

The power of trade unions
• There is a variety of factors which make trade unions more
or less powerful.
• Trade union membership and militancy
• A union which has 100 per cent membership in an industry
is likely to be stronger than a union which only represents
10 per cent of potential members. It could be argued that
the RMT is far more powerful in the railway industry than
the Transport and General Workers Union is in the
hairdressing industry. Equally, unions are more likely to call
for industrial action if union members are militant. The
more militant the union membership, the more costly a
dispute is likely to be for an employer.

• The demand-curve for labour is relatively
inelastic
• A rise in wage rates will have far less impact upon
employment in the industry if the demand for
labour is relatively inelastic than if it is elastic.
Hence, there will be far less cost to the union of a
wage rate increase in terms of lost membership
and to its members in terms of lost employment
(L 5 unit 71 for a discussion of why the ' demand
for labour might be inelastic).

• Profitability of the employer
• A trade union is unlikely to be able to negotiate
large wage increases with an employer on the
verge of bankruptcy. It is likely to be in a. stronger
position with a highly profitable firm. This implies
that trade unions will be stronger in monopolistic
and oligopolistic industries, where firms are.able
to earn abnormal profit, than in perfectly
competitive industries where only normal profit
can be earned in the long run.

Determinants of Demand for labor
• Before we proceed further it is useful to
summarize the determinants of the demand for a
variable factor by an individual firm. The demand
for a variable factor depends on
• 1) • The wage rate. This determines the position
on the demand curve. (Strictly speaking we
would refer here to the wage determining the
'quantity demanded' rather'. than the `demand'.)
• 2) • The productivity of labour (MPPL). This
determines the position of the demand. Curve.

• • The demand for the good. The higher the
market demand for the „good, the higher will be
its market price, and hence the higher will be the
MR, and thus the MRPL. This too determines the
position of the demand, curve. It shows how the
demand for labour (and other factors) is a
derived demand: i.e. one derived from the
demand for the good. For example, the higher
the demand for houses, and hence the higher
their price, the higher will be the demand for
bricklayers.

• The amount of the other factors which are
combined with labour. An increase In the
collaborating factors will shift the MPPL
outwards to the right and hence will raise its
V.41/31 curve (and vice versa).
• 5).The prices of other factors, since these
prices will determine their demand (and
hence the demand for labour).

• 6).The technological progress. Technological
progress changes the marginal physical
product of all inputs, and hence their demand.
-
• A change in the wage rate is represented by a
movement along the demand curve for labour.
A change in the productivity of labor or in the
demand for the good shifts the curve.

DETERMINANTS OF SUPPLY OF
LABOUR
• The supply of labor in each market will
typically be upward sloping. The higher the
wage rate offered in a particular type of job,
the more people will want to do the job.
• The position on the market supply curve of
labor will depend on the number of people
willing to do the job at each given wage rate.
This depends on these things:

LABOUR
• The number of qualified people
• The non-wage benefits or costs of the job, suc as
the pleasantness or otherwise of the working
environment, job satisfaction or dissatisfaction,
status, ower, the degree of job security, holiday,
perks and other fringe benefits.
• The wages and non-wage benefit in alternative
jobs.
• The tastes of consumers, which define their
trade-off between leisure and work.
• The size of the population.

LABOUR
• The labor force participation rate.
• The occupational, educational and geographic
distribution of the labor force.
• Age & sex distribution of population.
• Labor laws for school leaving age & retirement age.
• Women participation.
• A change in the wage rate will cause a movement
along the supply curve. A change in any of these three
determinants will shift the whole curve: a rightward
shift representing an increase in supply.

Elasticity of demand & supply of labor
• Elasticity of supply of labor to an industry
• Availability of suitable labor in other industries. An
engineering company wanting to recruit unskilled
workers will be able to 'poach workers relatively
easily from other industries because there is a large
pool of unskilled workers spread throughout industry.
The National Health Service will have more difficulty
recruiting brain surgeons because nearly all brain
surgeons in the UK are already employed by the NHS.
So the elasticity of supply of a pool of workers spread
across many industries is likely to be bight than that
of a group of workers concentrated in the recruiting
industry.

• Time: Elasticity of supply is likely to lower in
the short run than in the long run. For
instance, the NHS might not be able to recruit
large numbers of brain surgeons tomorrow.
But it could expand supply considerably over
a 20 year period by training more of them.

• Extent of underemployment & employment
• The higher level of employment, the higher I
likely to be elasticity of supply. With high
unemployment, firms are more likely to be
able to recruit workers at the existing real
wage rate from the pool of the unemployed.

• Determinants of the elasticity of demand for labor
• The elasticity of dement for labour is a measure of
the responsiveness of the quantity demanded of
labour to changes in the price of labour (i.e. the wage
rate, units 8 And 9 for a full discussion of elasticity).
For instance, if elasticity of demand for labor was 2
and wage rates increased 10 per cent then, all other
things being equal, the demand for labour would fall
by 20 per cent. If demand for labour fell by 1 per cent
when wage rates rose by 100 per cent, all other things
being equal, then elasticity of demand for labour
would be 0.01 (Le. highly inelastic).

• Time: The longer the time period for adjustment, the
easier it is to substitute labour for other factors of
production or vice versa. In the short term, a firm may
have little choice but to employ the same number of
workers even if wage rates increase rapidly: Workers will
have contracts of employment. There may be severe
financial penalties in the form of redundancy payments if
workers are sacked. Or a firm may not wish to lose skilled
staff because they would be difficult to replace. In the
longer term, the firm can buy new labour saving
machinery arid carry out changes in its methods of work
which will reduce the laboui employed. Hence the longer
the time period, the higher will tend to be the elasticity of
demand for labour.

• Availability of substitutes. The easier it is to
substitute other factors for labour, the
greater will be the response by firms to a
change in real wage rates. So the better the
substitutes, the higher will tend to be the
elasticity of demand for labour.

• Elasticity of demand for the product Labour is a droved demand. It
is only demanded because the goods that it produces are
demanded. For instance, if there is a collapse in demand for coal,
then there will also be a collapse in the-demand for coal miners.
This means that the elasticity of demand for labour in an industry
is directly correlated with the elasticity of demand for the product
made in the industry. If the elasticity of demand for the product is
low, as for instance for gas or electricity, then a sudden rise in
wages which pushes up gas or electricity prices will have little
effect on demand for gas or electricity. There will be little effect
on employment in the industry, and hence the demand for labour
will be low. If, on the other hand, elasticity of demand for the
product is high, elasticity of demand for labor will be high. Corus
Group (formerly British Steel), for instance, faces highly elastic
demand for many of its product: A rise in wages not matched
elsewhere in the industry is likely to increase its prices and lead to
a loss of orders and therefore jobs.

• The proportion of labour cost to total cost A rise in
costs will reduce the supply of a product, shifting the
supply curve upwards and to the left This will lead to
a reduc8en in quantity demanded. The bigger the
shift, the larger the reduction in demand- If a group of
workers gains a 50 per cent pay rise but these
workers only account for one Fee cent of the total
cost of production, then the supply curve of the
product-will hardly shift. There will be little fall in
demand and hence little loss of employment in the
rate-however, this-group of workers accounted for 58
Queen, of the costs of the firm, then a 50 per cent pay
rise wow" have a dramatic effect on the supply curve
and lead to a large decrease in quantity demanded of
the product. This in turn would lead to a large fall in
employment fleece' the larger the proportion of
labour cost to total cost the higher the elasticity of
demand for labor.

WAGE DIFFERENTIALS
• There are wide differences in wages received by individuals
from occupation; to occupation, from industry to industry,
from district to district and from region to region within. A
country. International, wage differences are however the
greatest. Why. is that a college lecturer with pleasant work,
long vacations and interesting students it receives more
pay than a bus driver's nerve-straining, backbreaking and
tiresome job? . Why is it that as agricultural laborer
receives a new lower wage per hour than a coal miner, a
factory worker at LONDON receives less than a: worker at .
LAHORE , and a worker at Faisalabad gets a lower- wage
than a worker at Karachi? The causes of these various types
of wage differentials are numerous.

WAGE DIFFERENTIALS
• Let us first examine how Wage differential-
arise. Assume-that there are two types of
labour, skilled and unskilled, each with a given
supply curve. The market demand for each
type Of labour is the aggregate MRP curve,
Derived on the summation of the individual
firms' marginal revenue product curves, - • ,.

• The two markets are shown in figures 21.43 and
21.44. The supply of skilled labour is zero below
the wage rate w„ prevailing in the market
[unskilled .labour: 'If the wage' for skilled labour
is below w„ nobody would be sing to undertake
the cost and effort required to acquire the skills
of the skilled Orket. --tie equilibrium wages are
defined by the intersection of the demand and
supply in each market. At equilibrium the wage
differential between skilled and unskilled labour
is wu

WAGE DIFFERENTIALS
• The causes of wage differentials can be classified
in four groups:
• (a) Differences in the nature of the various
occupations,
• (b) Differences in the biological and acquire ('
abilities of the various individuals which give rise
to differences in their marginal productivities,
• (c) Differences in- the price of the output which
labour produces, market imperfections
• (f) - Wage Discrimination

WAGE DIFFERENTIALS
• A) Differentials arising from characteristics of the
occupations are called comperrsating equalizing
differentials, because they represent payments made to
equalize net remuneration and compensate the workers
for differences in their job. Such differences arise from the
following factors.
• 1) Differences in the cost of training. Some occupations
require large investments in training, while others require
a much smaller expenditure for training. A 'physicist must
spend eight years in undergraduate and graduate training.
A surgeon may require ten or more years of training.
During this period income is forgone and heavy
educational costs must be-incurred.

WAGE DIFFERENTIALS
• 2) Differences in the costs of performing the job. For example
dentists, psychologists and doctors in general require expensive
equipment and incur high expenditures for running their practice.
In order for net compensation to be equalized such 'workers' must
be paid more than others.
• 3) Differences in the degree of difficulty or unpleasantness of the
work. For example miners work Under unpleasant conditions
relative to farmers.
• 4) Differences in the risk of the occupation. For example a racing
driver or an airplane pilot run more risks than a college teacher.
• 5) Differences in the number of hours required for an 'adequate'
practice. For example doctors are required to put longer hours in
practicing their profession than post office employees.

WAGE DIFFERENTIALS
• 6) Differences in the stability of employment. Construction work
and athletic coaching arc subject to frequent layoffs and hence
have little job security, whereas tenured university teachers have
a high job security.
• 7) Differences in the length of the employment. For example
boxers and football players have a short working life.
• 8) Differences in the prestige of various jobs. For example a white-
collar worker has a more prestigious position in society than a
truck driver.
• 9) Differences in the environment. For example an engineer sent
to Alaska or to a politically unstable African nation must be paid
more than an engineer working is London.
• 10) Differences in the cost of living in various areas. Living costs
generally are lower in small towns than in big cities

WAGE DIFFERENTIALS
• B) Differentials in wages arise also from biological acquired
differences in the quality of labour offered by various people.
These are called non-equalizing or not. Compensating wage
differentials because they are due to the differences in The
marginal productivities of individuals. Human beings are, born
with different in different environments, which. Define largely the
opportunities to. Develop their different qualities. For example-
not many people are born with the biological ties required for
becoming successful tennis players or surgeons, writers or artists*
And relatively few have the means and opportunities to develop
themselves into tennis players or surgeons or artists. Biological
and acquired quality differences' among people are the major
reasons why there are so many different wage rates even within
the same occupation; the marginal productivities-of workers
differ.

Transfer earnings economic rent quasi
rent
• The theory of economic rent distinguishes
between two dements in the payment made
to a factor of production. 7
• • The TRANSFER EARNINGS of the factor. This
is the minimum payment needed to keep the
factor in its I 'present use. If a worker is paid
£.200a.week, but could only earn £150 a
week.

rent
• in her next best paid occupation, then her
transfer earnings would be £150 per week.
Transfer earnings are the opportunity cost of
employing the factor. A change in transfer
earnings will affect the allocation of resources. If
the worker could now earn £250 a week in her
next best paid occupation, economic
• Theory would predict that all other things being
equal she would leave her present £200 a week
job and take the more highly paid job.

• • The ECONOMIC RENT of the factor.
Economic rent is the payment over and above
the minimum needed to keep the factor in its
present use (i.e. it is the difference between
its current payment and its transfer earnings).
Economic rent will not affect the allocation of
resources.' If the transfer earnings of a worker
were £150, she would remain in her present
job whether she earned • £200 a week or
£250 a week.

Earnings are zero and hence all the payments received from the use of the machine are quasi-
economic rents. In the long run, the machinery must be replaced completely or not at all, and
hence part or all of the earnings of this piece of capital will be transfer earnings. In the long run
the machine will need at least to cover its economic cost or it will not be replaced.

Transfer earnings, economic rent,
quasi rent
• Government policy
• The amount of economic rent earned by a factor of
production will not affect the allocation of resources
within the economy. Hence, it is theoretically possible
for • the government to tax economic rent from a fact-
or without altering economic efficiency in the economy
• For instance, the UK government places heavy taxes
upon North Sea oil production, but attempts to levy
them in such a way as not to discourage the
development of marginal fields (i.e. oil fields which are
only just profitable and which would not be developed
if costs, including taxes, were higher). •

rent
• Those who argue in favor of taxing economic rents usually want to
see a redistribution of income from rich to poor. They argue that it
offends against principles of equity that owners of some factors of
production should receive high payments whilst others should
receive little or nothing. Why should footballers or pop stars earn
hundreds of thousands of pounds a year when many workers earn a
wage which is less than one per cent of that figure? Why should a
fanner suddenly acquire a Windfall gain of a million because his
land has been given residential planning permission by the local
council? The problem with a tax on economic rents is that it is very
difficult to tax just economic rent and not tax transfer earnings. As
soon as transfer earnings are taxed, there will be allocative effects
and there may be a loss of efficiency in the economy

Are minimum wages justified?
• Fixing minimum wage by the state tends to remove exploitation.
• Minimum wages will so not the incomes of workers that their
consumption expenditures: - -re. While" increase which will in turn
lead to an expansion- of: the consumer’s goods industries and via
the acceleration principle to the capital goods industries. All this will
tend.to stimulates employment, output and national income.
Minimum wages prove beneficial both to the .employers and the
community by increasing the e5ciency and productive capacity of
the industry. Higher wages by raising the standard of living increase
efficiency' and even the bargaining power of the workers. Thus
higher wages- by raising productivity encourage employers -to
adopt better techniques of production, .weed out the inefficient -
employers and increase national income. Minimum wages, it-
related to the cost of living, as is the case in advanced countries,
tend to reduce labor unrest and maintain industrial peace.

• They also cause a more distribution of income. Lastly,
when the State fixes a minimum wage. For all -
employments,' it makes the supply curve of labour
horizontal to an employer at that level. There is no
possibility of paying the workers; below that. The
reduction in employment is also not possible as all
workers to be paid the minimum rate. Those employers
who are not in a position to pay the minimum wage
will not close down in a short-run they will try to cover
increased costs by raising the price of the product and
pass the burden on to the consumer. This is possible if
the demand for the product is inelastic. There is, of
course, another side to this problem of minimum
wages. If the minimum wage is fixed above the
competitive level in an -industry, there will be
diminution in employment because profits will fall
below normal profits.

• Any attempt to raise the price of the product will depend
upon its elasticity of demand. If the-demand is inelastic, the
wage rise can be passed on to the consumer by raising the
price of the product to that extent and the level, of
employment will not be adversely affected. If, however, the
demand for product is elastic, raising the wage level will
reduce unemployment much
• - If minimum wages are also fixed for export industries
above. The competitive level, country's export trade will
suffer. For casts rise, profits shrink, output declines and the
competitive strength of that industry falls in the face,-of
world competition: This with-not only reduce employment
but also the national income.- If the nations minimum wage
is fixed above the competitive level, similar results will
follow on a much larger scale.

• The fixing of minimum wages often leads to the. Change in
its personnel by' a firm.. If _the minimum rates. The same
for women and men, men may replace the former or the
young may replace the old and the infirm workers. If,
however, Special exemptions are granted from the
minimum wage to the sub-normal or slow workers as is the
practice in Australia and England, the firm will employ
more such workers and then turn them out when they have
to be paid the minimum wage
• It is commonly felt that with the fixation of a national
minimum wage, the minimum 'will become the maximum.
Employers already paying more will have the tendency to
level- down, the wage- is s, This has not been the
experience in Australia, America and England-where firms
continue to pay More than the minimum in the interests of
higher productivity and industrial.

• AS a general principle, there should be a national minimum for all
employments in the country. There should be no exception to this
rule based even on the capacity of the industry to pay or to meet
the export requirements of the country. Neither should there be a -
rate higher than the minimum for workers of the same category.
Such difference can be ironed by the State through appropriate'
fiscal measures. . There is however the problem of enforcing the
minimum rates where strong trade unions do not exist. as in
underdeveloped court-"tries. The responsibility for the
enforcement of -Minimum wages, therefore, devolves upon the
labour department and its inspectorate It is only when the
inspectorate staff is sufficient and honest the minimum wage laws
can curtail monopsonistic tendencies in under developed countries
and raise the productive efficiency of the workers.
Are minimum wages justified?

Bahria a2 economics labor markts

Bahria a2 economics labor markts

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