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Labor Markets and Labor Unions

Chapter 12

© 2006 Thomson/South-Western

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Three Uses of Time

Individuals can use their time in three waysUndertake market work selling time in

the labor market in return for incomeUndertake nonmarket work using time to

produce their own goods and servicesSpend time as leisure all nonwork uses of

their time

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Work and Utility

Work is not a pure source of utility, rather it is a source of disutility the opposite of utility

Net utility of work -- the utility of consumption made possible through work minus the disutility of the work itself; usually makes some amount of work an attractive use of part of an individual’s time

In the case of market work, the individual’s income buys goods and services

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Utility Maximization

Within the limits of a 24-hour day, seven days a week, individuals can balance their time among market work, nonmarket work, and leisure in order to maximize utility

The rational consumer will attempt to maximize utility by allocating time so the expected utility of the last unit of time spent in each activity is identical

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Implications

The higher your market wage, other things constant, the higher your opportunity cost of leisure and nonmarket work

The higher the expected earnings right out of high school, other things constant, the higher the opportunity cost of attending college

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Wages and Individual Labor Supply

An increase in the wage affects an individual’s choice between market work and other uses of time in two ways:Substitution EffectIncome Effect

As wage increases, market work is substituted for other activities substitution effect of a wage increase

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Income Effect

A higher wage means a higher income for the same number of hours, so demand for all normal goods increases

Leisure is a normal good, so higher income increases the demand for leisure and the allocation of time to market work declines

The income effect of a wage increase tends to reduce the quantity of labor supplied to market work

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Exhibit 1: Individual Labor Supply Curve for Market Work

The individual supply curve slopes upward until a wage of $12 is reached: at $12, the substitution effect dominates – the quantity of labor supplied increasesAfter a wage of $12, the labor supply curve bends backward and the income effect dominates – the quantity of labor supplied decreases

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Nonwage Determinants of Labor Supply

Supply of labor to a particular market depends on a variety of factors other than the wageOther sources of income

Nonmonetary factors

Value of job experience

Taste for work

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Other Sources of Income

The willingness to supply time to a labor market depends on income on other sources, including prior savings, borrowing, family support, and similar sources

More generally, wealthy people have less incentive to work

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Nonmonetary Factors

Difficulty of the job: the more difficult the job, the higher the wage must be, all other things being equal

Quality of the work environment: the more attractive the working conditions, the more labor an individual will supply to that particular market, other things constant

Status of the position: the higher the status, the more labor an individual will supply to that market, other things constant

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Exhibit 2: Market Labor Supply CurveThe labor supply curves of different individuals do not bend backwards at the same time – here we have three individual supply curves that sum to a market supply curve that slopes upward over the realistic range of wages

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Why Wages Differ

Wage differences across markets trace to differences in a number of factorsDifferences in training, education, age, and

experienceDifferences in abilityDifferences in riskGeographic differencesJob discriminationUnion membership

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Exhibit 3 Average Hourly Wage By Occupation

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Why Wages Differ

Training, Education, Age, and ExperienceSome jobs pay more because they require a

long and costly training periodFewer individuals are willing to incur the time

and expense requiredResults in a smaller market supply

However, extensive training increases the productivity of labor There is increased demand for these skills

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Exhibit 4 Age, Education, and Pay

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Why Wages Differ

Differences in abilityAbilityRiskGeographicsJob discriminationUnion membership

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Types of Unions

A labor union is a group of workers who join together to improve their terms of employment

Craft unions are confined to those with a particular skill, or craft

Industrial unions include unskilled, semiskilled, and skilled workers in a single industry, such as all autoworkers or all steelworkers.

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Collective Bargaining

Collective bargainingProcess by which representatives of union and

management negotiate a mutually agreeable contract specifying wages, employee benefits, and working conditions

MediatorAn impartial observer who listens to both sides

separately and then suggests how each side could adjust its position to resolve differences

Binding arbitrationProcess whereby a neutral third party evaluates

both sides of the dispute and issues a ruling that both parties must accept

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The Strike

A strike is a union’s attempt to withhold labor from the firm

Purpose of a strike is to stop production, thereby forcing the firm to accept the union’s position

Strikes also impose significant costs on union members

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Union Wages and Employment

A menu of union desires includes higher wages, more benefits, greater job security, better working conditions, and so on

Three ways that a union can try to increase wagesBy forming an inclusive, or industrial, unionBy forming an exclusive, or craft, unionBy increasing the demand for union labor

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Exhibit 5: Effect of a Union’s Wage Floor

W

Labor per period

D

(a) Industry

W

Labor per period

s

d = Marginalrevenue product

(b) Firm

Wag

e ra

te

Wage rate

E e

In the absence of a union, equilibrium wage is W and equilibrium employment level is E.

At the market wage, individual employers face a horizontal, or perfectly elastic, supply of labor, s.

Each firm can hire as much labor as it wants at the market wage of W A firm hires up to the point where labor’s marginal revenue product equals its marginal resource cost, quantity e

S

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Exhibit 5: Effect of a Union’s Wage Floor

W

Labor per period

D

SS(a) Industry

W

Labor per period

s

d = Marginalrevenue product

(b) Firm

Wag

e ra

te

Wag

e ra

te

a

E''

W' W' s'

E e

•If the union negotiates a wage above the market-clearing wage at W‘, no labor will be supplied at a lower wage. In effect, the supply of union labor is perfectly elastic at the union wage out to point a. •If more than E'‘ workers are demanded, the wage floor no longer applies and the upward-sloping portion, aS, becomes the relevant part of the labor supply curve W'aS.

For an industry facing a wage floor of W', the entire labor supply curve is W'aS ,which has a kink where the wage floor joins the upward-sloping portion of the original supply curve.

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Exhibit 5: Effect of a Union’s Wage Floor

W

Labor per period

D

S

(a) Industry

W

Labor per period

s

d = Marginalrevenue product

(b) Firm

Wag

e ra

te

Wag

e ra

te

a

E''

W' W'

e'

s'

E' E e

Once this wage floor has been established, each firm faces a horizontal supply curve of labor at the collectively bargained wage, W’. Since the wage is now higher, the quantity of labor demanded by each employer declines from e to e' as seen in the right panel.

The higher wage leads to a reduction in total employment as shown by the decline from E to E' in the left panel. Each firm faces a horizontal supply curve of labor at the collectively bargained wage quantity of labor demanded by each employer declines from e to e’

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Exhibit 5: Effect of a Union’s Wage Floor

W

Labor per period

D

S(a) Industry

W

Labor per period

s

d = Marginalrevenue product

(b) Firm

Wag

e ra

te

Wag

e ra

te

a

E''

W' W'

e'

s'

E' E e

At wage W’, the amount of labor that workers would like to supply, E”, exceeds the amount demanded, E’. In the absence of a union, this excess quantity of labor supplied would cause unemployed workers to lower their asking wage. With a union, workers cannot offer to work for less, nor can employers hire them at a lower wage.

Because of the excess quantity of labor supplied, the union must somehow ration available jobs, such as awarding jobs based on worker seniority or connections with the union

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Effect of Union Wage Floor

With the inclusive, or industrial, union the wage rate is higher and total employment lower than would be in the absence of a union

Those who cannot find union employment will look for jobs in the nonunion sector, causing the nonunion wage to be driven downward

Wages are relatively higher in the union sector for two reasons Unions bargain for wage higher than the market-

clearing wage Those unable to find employment in the union sector

crowd into the nonunion sector

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Exhibit 6 Median Weekly Earnings Are Higher for Union Than Nonunion Workers

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Exhibit 7a: Effect of Reducing Labor Supply

A successful supply restriction would be shown as the leftward shift from S to S'.

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Reducing Labor Supply

A successful supply restrictionRequires that the union:

limit its membership force all employers in the industry to hire only union members – a craft union

Membership can be restricted with high initiation fees, long apprenticeship periods, difficult qualification exams, and other devices

Defended on the grounds that they protect the public

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Exhibit 7b: Effect of Increasing Labor Demand

Third way of increasing wages is if the union can somehow increase the demand for labor by causing the demand curve to shift from D to D“This is a more attractive alternative because it increases both the level of employment – E to E''– and the wage rate – W to W' – there is no need to ration jobs among union members

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Increasing the Demand for Labor

Increase demand for union-made goodsRestrict supply of nonunion-made goodsIncrease productivity of union labor

Some claim that unions increase worker productivity by minimizing conflicts, resolving differences, and monitoring workers

If this is indeed true, the demand for union labor should increase

Featherbedding

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Featherbedding

Union efforts to force employers to hire more workers than wanted or neededDoes not create a true increase in the

demand, in the sense of shifting the demand curve to the right

Instead, forces firms to hire more labor than they really want or need, thus moving the firm to a point to the right of its true labor demand curve

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Recent Trends in Union Membership

In 1955, about one-third of wage and salary workers belonged to unions, now only one in seven belongs to a union

Government workers make up nearly half of all union members

Compared with other industrialized countries, the U.S. ranks relatively low in terms of unionization

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Recent Trends in Union Membership

Union membership rates vary greatly across states Rates tend to be highest in the Northeast United

States and lowest in the South

Decline in union membership is due partly to structural changes in the U.S. economy Employment in the industrial sector has been

declining, and increasing in the service sector Growth in foreign competition Near disappearance of strikes

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Exhibit 8 Unionization Rates by Age and Gender