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Free labour markets?

15 February, 2016 - 09:58

Real-world labour markets are characterized by trade unions, minimum wage laws, benefit regulations, severance packages, parental leave, sick-day allowances and so forth. So can we really claim that markets work in the way we have described them – essentially as involving individual agents demanding and supplying labour? But labour markets are not completely ’free’ in the conventional sense. The issue is whether these interventions, that are largely designed to protect workers, have a large or small impact on the market. It is often claimed that the reason why unemployment rates are generally higher in European economies than in Canada and the US is that labour markets are less subject to controls in the latter economies than the former.

Application Box: Are high salaries killing professional sports?

It is often said that the agents of professional players are killing their sport by demanding unreasonable salaries. Frequently the major leagues are threatened with strikes, even though players are paid millions each year. In fact, wages are high because the derived demand is high. Fans are willing to pay high ticket prices, and television rights generate huge revenues. Combined, these revenues not only make ownership profitable, but increase the demand for the top players.

If this is so why do some teams incur financial losses? In fact very few teams make losses: cries of poverty on the part of owners are more frequently part of the bargaining process. Occasionally teams are located in the wrong city and they should therefore either exit the industry or move the franchise to another market.

The impact of these measures on wages and employment levels can be determined with the help of the analysis that we have developed in this chapter. Let us see how in the case of unions.

In Figure 12.6 the equilibrium in a given labour market is at Eo, assuming that the workers are not unionized. If unionization increases the wage paid above Wo to W_1 then fewer workers will be employed. But how big will this reduction be? Clearly it depends on the elasticity of demand. If demand is inelastic the impact will be small and conversely if demand is elastic. If the minimum wage is substantially higher than the equilibrium wage, an inelastic demand will ensure that employment effects are small while cost increases could be large. In Measures of response: elasticities we saw that the dollar value of expenditure on a good increases when the price rises if the demand is inelastic. In the current example the ‘good’ is labour. Hence the less elastic is labour the more employers will pay in response to a rise in the wage rate. A case which has stirred great interest is described in Application Box.

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Figure 12.6 Market interventions

Eo is the equilibrium in the absence of a union. If the presence of a union forces the wage to W_1 fewer workers are employed. The magnitude of the decline from Lo to L_1 depends on the elasticity of demand for labour. The excess supply at the wage W_1 is (F-E_1).

Application Box: David Card on minimum wage

David Card is a famous Canadian-born labour economist who has worked at Princeton and Berkeley. He is a winner of the prestigious Clark medal, an award made annually to an outstanding economist under the age of forty. Among his many contributions to the discipline, is a study of the impact of minimum wage laws on the employment of fast-food workers.

With Alan Krueger as his co-researcher, Card examined the impact of the 1992 increase in the minimum wage in New Jersey and contrasted the impact on employment changes with neighbouring Pennsylvania, which did not experience an increase. They found virtually no difference in employment patterns between the two states. This research generated so much interest that it led to a special conference. Most economists now believe that modest changes in the level of the minimum wage have a small impact on employment levels.