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Theory of Distribution of Income. Theory of the Distribution of Income. Wages under Perfect Competition. Wages under perfect competition. Perfect labour markets assumptions no market power, everyone is a wage taker freedom of entry and exit perfect knowledge homogenous labour
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Theory of the Distribution of Income Wages under Perfect Competition
Wages under perfect competition • Perfect labour markets • assumptions • no market power, everyone is a wage taker • freedom of entry and exit • perfect knowledge • homogenous labour • market determination of wage rate
A labour market: whole market Sall workers in the market Dall firms in the market Wm Hourly wage O Labour hours
A labour market: individual employer Dindividual employer Firms are wage takers and thus face an infinitely elastic supply of labour. Slabour Wm Hourly wage Q1 O Labour hours
A labour market: individual worker Sindividual worker Dlabour Wm Hourly wage Workers are wage takers and thus face an infinitely elastic demand for labour. Q2 O Labour hours
Wages under perfect competition • The supply of labour • supply of hours by an individual worker • marginal disutility of work
The marginal disutility of hours worked MDU Disutility O Hours worked
Wages under perfect competition • The supply of labour • supply of hours by an individual worker • marginal disutility of work • income and substitution effects of wage changes • shape of the individual’s supply curve of labour
The supply of hours worked S Hourly wage O Hours worked
Backward-bending supply curve of labour S WI Above w1 the income effect of a higher wage rate is greater than the substitution effect. Hourly wage O Hours
The choice of hours worked at different wage rates B1 Wage rate of £5 per hour x I1 4 £150 Assume 12 hours available to be divided between work and leisure £120 Daily income £60 £40 O 12 Daily hours of leisure
The choice of hours worked at different wage rates B2 y I2 Wage rate of £10 per hour 3 £150 Higher wage rate (£10) causes the person to work one more hour. Substitution effect outweighs income effect. £120 Daily income B1 £60 x £40 I1 O 12 4 Daily hours of leisure
The choice of hours worked at different wage rates B3 z I3 Wage rate of £12.50 per hour Higher wage rate (£12.50) causes the person to work less. Income effect outweighs substitution effect. This gives backward-bending supply curve of labour. £150 B2 £120 y Daily income I2 B1 £60 x £40 I1 O 12 3 4 Daily hours of leisure
Wages under perfect competition • The supply of labour • supply of hours by an individual worker • marginal disutility of work • income and substitution effects of wage changes • shape of the individual’s supply curve of labour • supply of labour to an individual employer • market supply of a given type of labour
Wages under perfect competition • Elasticity of supply • the mobility of labour • geographical mobility • occupational mobility • economic rent and transfer earnings
Wm Qm The market for nurses S Wage rate D O Number of nurses
Transfer earnings (2) The market for nurses S b Wm Wage rate Economic rent (1) a D Qm O Number of nurses
Economic rent The market for Dame Edna Everage S W Dame Edna’s salary D 2 1 Number of Dame Ednas
Wages under perfect competition • The demand for labour: marginal productivity theory • marginal revenue product of labour (MRPL )
Marginal physical product of labour curve MPPL x Diminishing returns set in here Output O Q of labour
The profit-maximising level of employment Profit maximising employment of labour. MCL= W Wm MRPL £ MRPL = MPPL× Pgood Qe O Q of labour
Wages under perfect competition • The demand for labour: marginal productivity theory • marginal revenue product of labour (MRPL ) • derivation of a firm's demand curve for labour
Deriving the firm’s demand curve for labour a b c MRPL £ MCL1 W1 MCL2 W2 MCL3 W3 At a wage rate of W2, Q2 workers will be demanded. Thus point b is another point on the demand curve. At a wage rate of W1, Q1 workers will be demanded. Thus point a is one point on the demand curve. Profits maximised where MRPL = MCL At a wage rate of W3, Q3 workers will be demanded. Thus point c is another point on the demand curve. O Q1 Q2 Q3 Q of labour
Deriving the firm’s demand curve for labour a MCL1 W1 b MCL2 W2 c MCL3 W3 £ The MRPL curve traces out the demand curve D O Q1 Q2 Q3 Q of labour
Wages under perfect competition • The demand for labour: marginal productivity theory • marginal revenue product of labour (MRPL ) • derivation of a firm's demand curve for labour • derivation of the industry demand curve for labour
Using the firm’s demand curves for labour to derivethe industry demand curves for labour a £ W1 MCL1 MRP1 O Q of labour
Using the firm’s demand curves for labour to derivethe industry demand curves for labour b MRP2 £ a W1 MCL1 W2 MCL2 A fall in the wage rate will increase industry output and hence push down the price. This will shift the MRP curve inwards. MRP1 O Q of labour
Using the firm’s demand curves for labour to derivethe industry demand curves for labour b c MRP2 £ a W1 MCL1 W2 MCL2 The industry demand for labour is the horizontal sum of the green lines (connecting points a and c) MRP1 O Q of labour
Wages under perfect competition • Elasticity of demand for labour • determinants of elasticity • price elasticity of demand for the good • ease of factor substitution • elasticity of supply of other factors • wage costs as a proportion of total costs • time period
Wages under perfect competition • Wages and profits under perfect competition • MRP slopes down, thus last worker adds less to revenue than previously employed workers • if all workers are paid the MRP of the last worker , there is a surplus for the firm over its wage bill, contributing to profits
Wages and profits MRPL £ Profit maximised at employment of Qe MCL = W W O Qe Q of labour
Wages and profits MRPL £ Surplus for firm MCL = W W Wages O Qe Q of labour
Wages under perfect competition • Equality and inequality of wages under perfect competition • equality will exist when: • workers have identical abilities • there is perfect knowledge • there is perfect mobility in long run • all jobs are equally attractive
Wages under perfect competition • In practice, inequality of wages between markets will persist under perfect competition • jobs are not identical • workers’ abilities are not identical • demand and supply are constantly changing • Factors that contribute to poverty under perfect competition include • lack of skills that increase productivity • participation in labour markets with high level of supply/ low demand • working in contracting industries
Theory of the Distribution of Income Wage Determination in Imperfect Markets
Wages in imperfect markets • Types of factor market power • Firms with monopsony power in employing labour • MCL > W
MCL ACL º W (supply curve) MRPL Monopsony £ O Q of labour
Wages in imperfect markets • Types of factor market power • Firms with monopsony power in employing labour • MCL > W • effects on wages and employment
Profit maximised where MCL = MRPL Perfectly competitive equilibrium Q1 Monopsony £ MCL ACL º W (supply curve) W2 W1 MRPL O Q2 Q of labour
Wages in imperfect markets • Types of factor market power • Firms with monopsony power in employing labour • MCL > W • effects on wages and employment • Unions with monopoly power • employers with no market power • effects of wage increases on employment
Monopoly union facing producers under perfect competition W1 £ S D O Q1 Q of labour
Monopoly union facing producers under perfect competition Excess supply of labour £ S W2 W1 D O Q2 Q1 Q3 Q of labour
Wages in imperfect markets • Types of factor market power • Firms with monopsony power in employing labour • MCL > W • effects on wages and employment • Unions with monopoly power • employers with no market power • effects of wage increases on employment • Bilateral monopoly • no unique equilibrium • relationship between wage rates and employment
Bilateral monopoly S1 (=ACL1) MCL1 No union No union MRPL £ Monopsony: no union W1 O Q1 Q of labour
Bilateral monopoly MCL1 No union MRPL £ S1 (=ACL1) x MCL2 = ACL2 W2 Bilateral monopoly No union W1 O Q3 Q1 Q of labour
Bilateral monopoly MRPL £ MCL1 x MCL2 = ACL2 W2 Wage can rise to W2 with no fall in employment W1 O Q1 Q of labour
Bilateral monopoly MRPL £ MCL1 x W2 MCL3 = ACL3 W3 Wage can rise from W1to W3 and employment rises to Q2 W1 O Q2 Q1 Q of labour
Wages in imperfect markets • Collective bargaining
UK trade union membershipas % of total employed plus unemployed % Sources: A. Marsh and B. Cox, The Trade Union Movement in the UK 1992 (Malthouse Press); Trade Union Membership (BERR)