Week2 - Wage Determination and Policy

• draw and derive wage determination in a perfectly competitive setting

  
• what does a shock in supply or demand cause

  an adjustment in wages and labour employed
• what effects does a negative demand shock have on the diagram

  shifts the labour demand down
• draw the gains from trade

  A - producer surplus

  B - consumer surplus

  
  

  gains from trade = A + B

  
• give an example of downward wage rigidity and its effects

  occurs when there is an 'imperfection' i.e. unions that stop wages adjusting downwards

  
  

  involuntary unemployment emerges leading to deadweight welfare loss
• draw downward wage rigidity

  - firms hire L1 workers at w*

  - but L2 workers would like to be employed

  - L1 to L2 is unemployment

  
• draw and explain multiple markets with wage differentials

  - 2 distinct markets linked by costless migration

  - workers in the North are paid more

  - so workers from the South migrate to the North, moving labour supply inward for the South and outward for the North

  - this occurs until wages equalise

  
• what paper suggests that wages converge

  Blanchard and Katz, 1992 in the US
• explain conditional convergence

  - two countries with similar human capital and other factors of production

  - the wage gap tends to narrow over time, conditional on the similar characteristics
• what are two common forms of policy which have an effect on employment and wages

  i. payroll taxes

  ii. minimum wages
• what are the two types of payroll taxes

  can either be a deduction from wages (income taxes or national insurance) or payments by the employer on the basis of how much their employees earn
• explain payroll taxes levied on employers

  - for every worker hired the firm pays £1 in tax

  - workers wages drop

  - employment falls

  - W1+1 is the amount the firm has to pay to hire workers at wage W1

  - cost of hiring workers increases

  
• explain payroll taxes levied on workers

  - supply curve moves upwards

  - the same wag/employment outcome emerges as if the tax was levied on firms

  
• explain what happens when a payroll tax is assessed on a firm but passed onto the worker

  - there's a perfectly inelastic supply curve

  - the tax shifts entirely onto the worker

  - the tax shifts the demand curve down and the wage falls

  - there's no change in employment

  
• what does payroll taxes do to employment

  they reduce employment below the equilibrium level causing deadweight loss
• draw the effects of payroll taxes on employment (consumer, producer surplus and deadweight loss)

  
• what happens to the demand curve when a payroll tax is levied on firms

  demand shifts inwards
• what happens to wages when a payroll tax is levied on a firm

  wages fall
• what are minimum wages

  a wage floor below which it is illegal to hire workers
• what are the basic economics behind wage floors

  binding wage floors cause unemployment and are inefficient
• what is the social argument for wage floors

  poverty prevention, fairness, exploitation but are minimum wages actually a good way to address this?
• who are minimum wage workers and what does this mean

  minimum wage workers tend to be young people or secondary earners so they don't target households in financial difficulty
• define and explain the difference between a binding and non-binding minimum wage

  non-binding : a wage set below the equilibrium wage which has no effect on unemployment and wages

  
  

  binding : a wage set above the equilibrium wage and generates unemployment
• draw a binding wage graph

  
• explain how covered and uncovered sectors work

  i. imagine two sectors with initially the same wage

  
  

  ii. if one sector has a minimum wage then people will migrate to the uncovered sector

  
  

  iii. this causes lower wages in the uncovered sector as the supply curve shifts outwards

  
• what is the common contention regarding minimum wages in developing countries

  there is often a significant informal and hence uncovered sector meaning that covered sectors actually reduce the wages of those who need intervention the most
• describe and explain a scenario where workers try to equate expected wages

  i. this could lead to workers leaving the uncovered sector and queue for a minimum wage job

  
  

  ii. if there is a probability, π, of gaining employment in the covered sector and the return to getting a covered job is wmin then: (diagram)

  
• what empirical evidence is there about minimum wages and what is the relating paper

  UK - introduced in 1999 at £3.60 an hour or £3.00 for younger workers

  
  

  US - federal minimum wage but states can also set their own and workers who received tips may get a lower hourly minimum wage

  
  

  initial papers focused on youth labour as that is who minimum wages target

  
  

  these papers find a small negative labour demand elasticity (-0.1 to -0.3) concluding that minimum wages reduce employment

  
  

  later quasi experimental work casts doubt on this

  
  

  Card & Krueger, 1994 - fast food (youth workers) didn't find negative effects of minimum wage

  
  

  Neumark & Wäscher, 2000 - finds a small negative elasticity of demand i.e. the increase reduced employment
• what are the issues with Card & Kruegers research

  i. not clear that surveying existing establishments is the right idea - raising the cost of labour may reduce entry so the employment effect is partly the dynamic effect on firm entry decisions and hence employment decisions

  
  

  ii. it may be an industry specific thing

  
  

  iii. it was based on very noisy data - telephone survey
• is it possible that theoretically minimum wages increase employment

  a firm would have to face an upward sloping supply curve (in a competitive market firms are price takers so each firm faces a flat labour supply curve)

  
  

  so monopsonies have an upward facing supply curve
• define and explain a monopsony


  there is only one firm who hires labour

  
  

  workers have the option to supply labour to this one firm or not at all

  
  

  the firm pays the same wage rate to all workers doing the same job

  
  

  this means that the Marginal Cost of Labour deviates from the labour supply curve
• what leads to a higher marginal cost of labour regarding monopsonies


  having to pay each existing worker the same as the last worker hired
• draw and explain the labour market in a monopsony


  - the firm hires until MCL=MRPL

  
  

  - so they hire less workers at a lower wage than in a competitive setting

  
  

  - a minimum wage can lead to higher employment (W* > Wmin > Wmon)

  
  

  - firms can hire as many workers as they want at a constant MCL (Wmin) up to the supply curve (then wage is equal to MCL)

  
  

  - this leads to higher employment

  
  

  - if the firm wants to hire more workers than the ones who are willing to work for minimum wage, then they must raise wages to MCL to attract the marginal worker and hence raise the wages of all previously employed workers

  
• why do some people think that all firms have some degree of monopsony power


  - searching for a job is costly, c

  
  

  - if an agents employer lowers their wage (Wmon) below the competitive wage (W*) it may not be optimal to switch jobs

  
  

  - so the return from chasing a job (W* - Wmon) may not be enough to cover the cost, c

  
  

  - so firms can offer a wage below the competitive wage and not instantly lose all of its workers
• outline what Dickens et al, 1998 finds about monopsony power


  - demonstrates how monopsonies can explain a positive effect but also why the level of the minimum wage may matter

  
  

  - the model is that firms differ in their demand curves (MRPL) but each act as a monopsonist hiring labour

  
  

  - there is a high demand, high wage firm, medium and low

  
  

  - shown how a given minimum wage can have no employment effect on MRPL1 firm, positive effect on MRPL2 firm and a negative effect on MRPL3 firm
• in Dickens et al, 1998, why do firms with high wages and high demand take no effect from a minimum wage


  they initially pay a higher wage so an imposition of a minimum wage is below the original wage level

  
• in Dickens et al, 1998, why do firms with medium wages and medium demand take a positive effect from a minimum wage


  these firms pay less than the minimum wage so the imposition of a wage floor increases the wage and employment as the wage increase is not extreme

  
• in Dickens et al, 1998, why do firms with low wages and low demand take a negative effect from a minimum wage


  these firms pay way less than the minimum wage so there's an increase in wages and a fall in employment after a wage floor has been set