© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-1

Chapter Fifteen

Wage and Employment Determination Under Collective Bargaining

Created by: Erica Morrill, M.Ed Fanshawe College

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-2

Chapter FocusUnion behaviour Interaction between firms and unions Inefficient production decisions Inefficient union practicesBargaining power

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-3

Theory of Union BehaviourUnions attempt to maximize objectives

given economic constraints Ability to characterize preferences of

unions is difficult

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-4

Union ObjectivesFactors influencing preferences

information available union’s political decision-making process degree of homogeneity

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-5

Union ObjectivesUtility is a positive function of wage rate

and employment Indifference curve is downward sloping

higher wage is needed to compensate for lower employment

Curves have a convex shape diminishing marginal rate of substitution

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-6

DL

Figure 15.1 Union Objectives and Constraints

Real WageRate

WP

Wa

P

Employment E

a2

a1

U0 a3

U2

a0

U1

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-7

Special Cases of Objective Functions

Maximize the Wage rate indifference curves are horizontal straight lines

Maximize Employment indifference curves are vertical straight lines

Maximize the (real) wage bill curve out from the origin-disregards alternative wage

rate Maximize economic rent

curve out from the intersection of alternative wage

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-8

Additional ConsiderationsDeriving union objectives is simplest

when: preferences are homogeneous leaders are constrained by democratic

decision-making processes union membership is exogenously

determined

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-9

Union Constraints (Wage Only)Unions negotiate wages taking into

account the consequencesThe firm decides the employment level

maximizing profits according to LD curveLD curve is analogous to a budget

constraint Equilibrium is the tangent of the iso-

utility curve and LD curve

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-10

Factor in the Firms Iso-profit CurvesCombinations of wage and employment

of equal profitsHigher profits on lower curvesFirm cannot pay wages below the

alternative wageWage will lie between the alternative

wage rate and the bargaining wage

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-11

Figure 15.4 The Firm’s and Union’s Preferred Wage-Employment Outcomes

E

W

DL

U*Iu

0=0W0

Wu

*

IfWf = Wa

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-12

Relaxing the Demand Constraint Unions will attempt to alter the constraint

increasing labour demand making demand more inelastic

Restricting substitution possibilities collective bargaining influencing public policy

Influence product market supporting quotas, tariffs and restrictions on foreign

competition

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-13

Efficient Wage and Employment ContractsNegotiating over wage and employment

is mutually advantageous Pareto-efficient wage-employment

outcomes union’s indifference curve tangent to the

firms iso-profit curve

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-14

U

Figure 15.5 Efficient and Inefficient Wage-Employment Contracts

DL

A

W

E

B

A’A’’

C

C’Wa

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-15

Contract Curve

Locus of the Pareto-efficient wage-employment outcomes

Union cares about wages and employment

CC must lie to the right of LD curve

Firms and unions are better off negotiating an outcome on the contract curve

Moving up on the CC unions better off Moving down the firm better off

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-16

Obstacles to Reaching Efficient Contacts Information needed may not be

availableAn agreement about employment

difficult to enforceConcession bargaining

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-17

Efficient Versus Inefficient ContractsLabour demand curve model

firm unilaterally sets employmentContract curve

negotiate over wage and employmentMonitoring and enforcing efficient

contracts are too high in most settings

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-18

Figure 15.6 Inefficient, Approximately Efficient, and Efficient Contracts

E

W

C’

C

DLC

DL

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-19

Theory of BargainingPredicting the outcome and explaining

depend factors Common features

Set of possible outcomes Minimum for each party Voluntary agreement Neither will agree to an outcome worse

than minimum

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-20

Figure 15.7 The Bargaining Problem and Nash Solution

F

U

F

U

S A

NUN

fNd

T

d f0

CU0

f1

U1

A

fN

UN

N

f2

U2B

The bargaining problem The Nash solution

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-21

Solutions to the Bargaining Problem

Two bargaining theories process outcome

Nash’s Theory Pareto-efficiency Symmetry Transformation invariance Independence of irrelevant alternatives

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-22

Solutions to the Bargaining ProblemRubinstein’s Theory

some concepts of non-cooperative game theory

bargainers take turns making offers counter offers can be made utility shrinks in each round

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-23

fA

UA

A

BUB

fBf1f2fR

UR

R

Figure 15.8 The Rubinstein Solution to the Bargaining Problem

F

U

F

RU1

f1d

df4

U0

Rubinstein’s Solution Effect of delay Costs

U4 f3 f2f3fR

UR

U2

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-24

Union Bargaining PowerTwo meanings

power is related to elasticity ability to raise wages

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-25

Union Power and Labour SupplyCraft Unions

raise wage by controlling entry through apprenticeship systems

discrimination, nepotism, high dues and closed shop, union shop, agency shop

Professional Associations occupational licensing and certification

© 2002 McGraw-Hill Ryerson Ltd. Chapter 15-26

End of Chapter Fifteen