3.5.3 - Wage determination

• Wage rates differ within an occupation due to age, education, training, work experience, skill/talent/ability to perform tasks, sex and ethnic background.
• The immobility of labour means that there may be excess supply in one area/occupation, causing low wages, and not enough workers in another, meaning high wages.
• The lower the elasticity of supply/demand, the greater the change in the real wage rate and the smaller the change in employment as a result of a change in demand/supply for labour. The effect will also depend on the size of the shift.
• Wage determination - Perfect competition:

  • In a perfectly competitive labour market, we make the same assumptions as in a perfectly competitive product market. Therefore, wages are determined purely by demand and supply and all workers are paid the same. If workers were not paid the same, they would simply move somewhere else where the wage rate in the industry was higher.
• Wage determination - Perfect competition:

  
• Wage determination - Monopsony in the labour market

  • In a monopsony market, there is only one buyer of the labour. In this situation, businesses know that if they want to increase their labour force they will have to increase the wage they offer and, just like with monopsony product markets, an increase in the wage for one increases the wage for all
• Wage determination - Monopsony in the labour market

  • The MC curve is above the supply curve (AC) of labour because it costs more to employ an additional worker than the average cost of labour. A firm will determine how many workers to employ where the cost of employing them is equal to the value of that worker to the company. They employ where MC=D at Q1 and at this output, they will pay their workers W1 (determined by the S curve). Compared to a perfectly competitive market (which would produce at W2Q2), they employ less people at a lower wage rate.

  A) MC

  B) S=AC

  C) D=MRP

  
• Wage determination - Bilateral monopoly:

  • It is possible for there to be both monopoly and monopsony in a labour market, called a bilateral monopoly.
• Wage determination - Bilateral monopoly:

  • The firm is a monopsonist and wants to employ at Q2W2. However, the union may decide to set a minimum wage at W1 and ensure that there is no one willing to work below this price, creating a kinked supply curve. The new MC and AC curves are the purple curves. In this situation, there is a battle going on between the two parties. The wage that is set will depend on the relative bargaining strength of both . This is dependent on a number of factors, including the size of the union and the strength of the economy.