31E00700 Labor Economics:

Lecture 6

Matti Sarvimäki

15 Nov 2012
Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

First Part of the Course: Outline

1 Supply of labor
2 Demand for labor
3 Labor market equilibrium
1 Perfectly competitive markets; immigration
2 Imperfectly competitive labor markets; minimum wages
(today)
3 Roy model; technological change and polarization

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Minimum Wages, U.S. 1938–2007

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Minimum Wages, U.S. 1938–2007

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

The Impact of Minimum Wages:
Perfect Competition

Dollars

w*

Employment

A minimum wage set at w − results in employers cutting employment from E ∗⇤

to E − . The higher wage also encourages ES − E ∗⇤ workers to enter the market.
Thus, under a minimum wage, ES − E − workers are unemployed.
The Impact of Minimum Wages:
Perfect Competition

Dollars

w−

w*

Employment

⇤
A minimum wage set at w − results in employers cutting employment from E ∗
⇤
to E − . The higher wage also encourages ES − E ∗ workers to enter the market.
−
Thus, under a minimum wage, ES − E workers are unemployed.
Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

NJ Minumum Wage Rise (Card and Krueger, 1994)

New Jersey’s minimum wage increased from $4.25 to $5.05

per hour on 1 April 1992
Card and Krueger study the impact on employment, wages and
prices at fast-food restaurants using a dif-in-dif approach
Data collected on March and Nov/Dec 1992
Control group 1: Stores in eastern Pennsylvania
Control group 2: High-wage (above $5) stores in NJ

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

NJ Minumum Wage Rise (Card and Krueger, 1994)

New Jersey’s minimum wage increased from $4.25 to $5.05

per hour on 1 April 1992
Card and Krueger study the impact on employment, wages and
prices at fast-food restaurants using a dif-in-dif approach
Data collected on March and Nov/Dec 1992
Control group 1: Stores in eastern Pennsylvania
Control group 2: High-wage (above $5) stores in NJ
Strenghts of the paper
the rise occured during a recession (decided two years earlier,
last-minute action to reduce the rise failed)
New Jersey and Pennsylvania closely linked (restaurants in
eastern Pennsylvania arguably in the same market)
low attirition in data collection

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Treatment and Control Locations

(Card and Krueger, 2000)

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Results of the CK Study

Wages increased by 10% in NJ, remained constant PA (Tab 2, Fig 1)

... but employment rose in NJ and decreased in PA (Tab 3–5)
The dif-in-dif estimate is statistically significant → if anything,
the rise of minimum wage increased employment
Result robust to alternative specifications and on using an
alternative control group
Entry/exit: no indication of an impact
Impact on prices: mixed results

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Reactions to the CK Study

Angus Deaton: “The reception accorded to Princeton faculty

by their colleagues in other institutions is what might be
expected by the friends and defenders of child-molesters”
(Nobel laurate) James Buchanan in the Wall Street Journal:
“no self-respecting economist would claim that increases in the
minimum wage increase employment. Such a claim, if seriously
advanced, becomes equivalent to a denial that there is even
minimum scientific content in economics, and that, in consequence,
economists can do nothing but write as advocates for ideological
interests. Fortunately, only a handful of economists are willing to
throw over the teaching of two centuries; we have not yet become a
bevy of camp-following whores”

See Angus Deaton’s “Letters from America” for more:

www.princeton.edu/~deaton/downloads/letterfromamerica_oct1996.html

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Reactions to the CK Study

Neumark and Wascher (2000, AER)

CK data has a lot of measurement error
data provided by Employment Policies Institute reveal that the
minimum wage rise did decrease employment

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Reactions to the CK Study

Neumark and Wascher (2000, AER)

CK data has a lot of measurement error
data provided by Employment Policies Institute reveal that the
minimum wage rise did decrease employment
Card and Krueger (2000, AER)
administrative data from Bureau of Labor Statistics confirm
the key findings of the 1994 paper
“calls into question the representativeness of the sample
assembled by Berman, Neumark and Wascher”
See John Schimtt’s “Cooked to Order“ for more:
www.prospect.org/cs/articles?article=cooked_to_order

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Monopsony, Oligopsony and Monopsonistic

Competition

Perfect competition implies that the wage elasticity of the

labor supply curve facing an individual firm is infinite
if the employer attempts to cut wages, all workers will leave

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Monopsony, Oligopsony and Monopsonistic

Competition

Perfect competition implies that the wage elasticity of the

labor supply curve facing an individual firm is infinite
if the employer attempts to cut wages, all workers will leave
Monopsony (single employer) implies that the marginal cost
curve lies above the labor supply curve
additional worker → all current workers have to be paid more
however, single employers rare (apart from the public sector)

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Monopsony, Oligopsony and Monopsonistic

Competition

Perfect competition implies that the wage elasticity of the

labor supply curve facing an individual firm is infinite
if the employer attempts to cut wages, all workers will leave
Monopsony (single employer) implies that the marginal cost
curve lies above the labor supply curve
additional worker → all current workers have to be paid more
however, single employers rare (apart from the public sector)
Oligopsony
many competing firms facing upward sloping labor demand
curve (mobility costs, heterogeneous preferences)
oligopsony + free entry → monopsonistic competition

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

A Simple Model of Oligopsony

(Bashkar, Manning and To, 2002)

two firms located at 0 and 1

eveyrone paid the same within firms
but wages may differ between firms
heterogeneous preferences wrt. nonwage job characteristics
“transportation costs” as a metaphor for many things (job
specification, commuting time, social environment etc.)
workers distributed uniformly along a straight line
workers willing to “travel” further if paid sufficient wage
premium (“compensating differential”)

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Allocation of Workers across Jobs

w0

net wage

0 1
Locaon

Net wage (wage–travel cost) is w0 for someone living at 0 and less for those
living further away from 0. Given wages {w0 , w1 }, everyone to the left of
x ∗ work at firm 0 and everyone else at firm 1. When firm 0 decreses wages from
0
w0 to w0− , x ∗ − x ∗ workers change employer form 0 to 1.
31E00700 Labor Economics: Lecture 6 Matti Sarvimäki
Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Allocation of Workers across Jobs

w0 w1

net wage

0 x* 1
Loca on

Net wage (wage–travel cost) is w0 for someone living at 0 and less for those
living further away from 0. Given wages {w0 , w1 }, everyone to the left of
x ∗ work at firm 0 and everyone else at firm 1. When firm 0 decreses wages from
0
w0 to w0− , x ∗ − x ∗ workers change employer form 0 to 1.
31E00700 Labor Economics: Lecture 6 Matti Sarvimäki
Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Allocation of Workers across Jobs

w0 w1

net wage

0 x*’ x* 1
Locaon

Net wage (wage–travel cost) is w0 for someone living at 0 and less for those
living further away from 0. Given wages {w0 , w1 }, everyone to the left of x ∗
work at firm 0 and everyone else at firm 1. When firm 0 decreses wages from
0
w0 to w0− , x ∗ − x ∗ workers change employer from 0 to 1.
31E00700 Labor Economics: Lecture 6 Matti Sarvimäki
Profit Maximization under Oligopsony

wage
MC0

LS0

Employment

Firm maximizes profits by employing L0 workers. To get them, the firm must
pay w0 (less than the marginal product of labor denoted with the straight solid
line).
Profit Maximization under Oligopsony

wage
MC0

LS0

W0

L0
Employment

Firm maximizes profits by employing L0 workers. To get them, the firm must
pay w0 (less than the marginal product of labor denoted with the straight solid
line).
Profit Maximization under Oligopsony

wage
MC0’ MC0

LS0’

LS0

W0’

W0

L0’ L0
Employment

When a rival raises wages, the labor supply curve shifts to the left and the firm
0
now maximizes profits by reducing employment to L0 . To get them, it must
0
pay w0 , i.e. more than before, so profits decrease. This increase will not be as
large as the increase of rival’s wages (but you can’t see the last point from the
graph).
Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Duopsony Wage Reaction Functions

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Duopsony Wage Reaction Functions

R1

R0

Firm 0’s wage

Firm 1’s wage

R0 maps firm 0’s optimal wage as a best response to wages offered by firm 1
(and R1 does the same the other way around). The equilibrium wage—where
the reaction curves cross—will be less than the marginal product of workers
(though you can’t see that from this graph).
31E00700 Labor Economics: Lecture 6 Matti Sarvimäki
Minimum Wages under Oligopsony

wage
MC0

LS0

W0

L
Employment

Minimum wages increase rival’s wages and thus push the labor supply curve
0
from LS0 to LS0 . Due to the minimum wages marginal cost of an additional
worker is fixed at wmin as long as LS0´ curve is below wmin . Thus minimum
0
wages lead the firm to increase employment from L0 to L0 and wages from w0
to wmin .
Minimum Wages under Oligopsony

wage
MC0’ MC0

LS0’

LS0

W0’
W0

L0’ L
Employment

Minimum wages increase rival’s wages and thus push the labor supply curve
0
from LS0 to LS0 . Due to the minimum wages marginal cost of an additional
worker is fixed at wmin as long as LS0´ curve is below wmin . Thus minimum
0
wages lead the firm to increase employment from L0 to L0 and wages from w0
to wmin .
Minimum Wages under Oligopsony

wage
MC0’ MC0

LS0’

LS0

Wmin
W0

L0’ L0
Employment

Minimum wages increase rival’s wages and thus push the labor supply curve
0
from LS0 to LS0 . Due to the minimum wages marginal cost of an additional
worker is fixed at wmin as long as LS0´ curve is below wmin . Thus minimum
0
wages lead the firm to increase employment from L0 to L0 and wages from w0
to wmin .
Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Minimum Wages under Oligopsony

Two opposing effects

1 Oligopsony effect may increase employment (increasing
firm-level employment does not affect wages of inframarginal
workers in the flat part of the curve)
2 Exit effect lowers employment (lower profitability → some firms
go bust)

In short, setting minimum wages moderately above market

wages may increase or decrease employment

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki

Introduction Card and Krueger (1994) A Model of Monopsonistic Competition

Other Empirical Findings Explained by Market

Power

1 Wage dispersions among identical workers

2 Market provision of general training
3 Racial pay gaps
Further reading: Alan Manning (2003): “Monopsony in Motion”. Princeton University
Press.

31E00700 Labor Economics: Lecture 6 Matti Sarvimäki