1

Labor Markets and Labor

Unions

Chapter 12
2006 Thomson/South-Western
2
Three Uses of Time
Individuals can use their time in three
ways
Undertake market work selling time in
the labor market in return for income
Undertake nonmarket work using time to
produce their own goods and services
Spend time as leisure all nonwork uses of
their time
3
Work and Utility
Work is not a pure source of utility, rather it is a
source of disutility the opposite of utility
Net utility of work -- the utility of consumption
made possible through work minus the disutility of
the work itself; usually makes some amount of
work an attractive use of part of an individuals
time
In the case of market work, the individuals income
buys goods and services

4
Utility Maximization
Within the limits of a 24-hour day, seven days a
week, individuals can balance their time among
market work, nonmarket work, and leisure in
order to maximize utility

The rational consumer will attempt to
maximize utility by allocating time so the
expected utility of the last unit of time spent in
each activity is identical

5
Implications
The higher your market wage, other things
constant, the higher your opportunity cost of
leisure and nonmarket work

The higher the expected earnings right out of
high school, other things constant, the higher
the opportunity cost of attending college
6
Wages and Individual Labor Supply
An increase in the wage affects an
individuals choice between market
work and other uses of time in two
ways:
Substitution Effect
Income Effect
As wage increases, market work is
substituted for other activities
substitution effect of a wage increase
7
Income Effect
A higher wage means a higher income for the
same number of hours, so demand for all
normal goods increases
Leisure is a normal good, so higher income
increases the demand for leisure and the
allocation of time to market work declines
The income effect of a wage increase tends to
reduce the quantity of labor supplied to market
work
8
Exhibit 1: Individual Labor Supply Curve for Market Work

The individual
supply curve slopes
upward until a wage of
$12 is reached: at $12,
the substitution effect
dominates the
quantity of labor
supplied increases
After a wage of $12,
the labor supply curve
bends backward and
the income effect
dominates the
quantity of labor
supplied decreases
9
Nonwage Determinants of Labor Supply
Supply of labor to a particular market depends
on a variety of factors other than the wage
Other sources of income

Nonmonetary factors

Value of job experience

Taste for work
10
Other Sources of Income
The willingness to supply time to a labor
market depends on income on other sources,
including prior savings, borrowing, family
support, and similar sources

More generally, wealthy people have less
incentive to work
11
Nonmonetary Factors
Difficulty of the job: the more difficult the job,
the higher the wage must be, all other things
being equal
Quality of the work environment: the more
attractive the working conditions, the more
labor an individual will supply to that
particular market, other things constant
Status of the position: the higher the status, the
more labor an individual will supply to that
market, other things constant
12
Exhibit 2: Market Labor Supply Curve
The labor supply curves of different individuals do not bend
backwards at the same time here we have three individual supply
curves that sum to a market supply curve that slopes upward over the
realistic range of wages
13
Why Wages Differ
Wage differences across markets trace to
differences in a number of factors
Differences in training, education, age, and
experience
Differences in ability
Differences in risk
Geographic differences
Job discrimination
Union membership
14
Exhibit 3 Average Hourly Wage By Occupation
15
Why Wages Differ
Training, Education, Age, and Experience
Some jobs pay more because they require a
long and costly training period
Fewer individuals are willing to incur the time
and expense required
Results in a smaller market supply
However, extensive training increases the
productivity of labor
There is increased demand for these skills
16
Exhibit 4 Age, Education, and Pay
17
Why Wages Differ
Differences in ability
Ability
Risk
Geographics
Job discrimination
Union membership
18
Types of Unions
A labor union is a group of workers who
join together to improve their terms of
employment
Craft unions are confined to those with a
particular skill, or craft
I ndustrial unions include unskilled,
semiskilled, and skilled workers in a
single industry, such as all autoworkers
or all steelworkers.
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Collective Bargaining
Collective bargaining
Process by which representatives of union and
management negotiate a mutually agreeable
contract specifying wages, employee benefits, and
working conditions
Mediator
An impartial observer who listens to both sides
separately and then suggests how each side could
adjust its position to resolve differences
Binding arbitration
Process whereby a neutral third party evaluates
both sides of the dispute and issues a ruling that
both parties must accept
20
The Strike
A strike is a unions attempt to withhold
labor from the firm

Purpose of a strike is to stop production,
thereby forcing the firm to accept the
unions position

Strikes also impose significant costs on
union members
21
Union Wages and Employment
A menu of union desires includes higher
wages, more benefits, greater job security,
better working conditions, and so on
Three ways that a union can try to
increase wages
By forming an inclusive, or industrial, union
By forming an exclusive, or craft, union
By increasing the demand for union labor
22
Exhibit 5: Effect of a Unions Wage Floor


W
Labor per period
D
(a) Industry


W
Labor per period
s
d = Marginal
revenue product
(b) Firm
W
a
g
e

r
a
t
e

Wage rate


E e
In the absence of a union, equilibrium wage is
W and equilibrium employment level is E.
At the market wage, individual employers face a
horizontal, or perfectly elastic, supply of labor, s.
Each firm can hire as much labor as it wants at the market wage of W
A firm hires up to the point where labors marginal revenue product equals its
marginal resource cost, quantity e
S
23
Exhibit 5: Effect of a Unions Wage Floor


W
Labor per period
D
S
(a) Industry


W
Labor per period
s
d = Marginal
revenue product
(b) Firm
W
a
g
e

r
a
t
e

W
a
g
e

r
a
t
e



a
E''
W' W' s'
E
e
If the union negotiates a wage above the market-clearing wage at W, no labor will be supplied at a
lower wage. In effect, the supply of union labor is perfectly elastic at the union wage out to point a.
If more than E' workers are demanded, the wage floor no longer applies and the upward-sloping
portion, aS, becomes the relevant part of the labor supply curve W'aS.
For an industry facing a wage floor of W', the entire labor supply curve is W'aS ,which has
a kink where the wage floor joins the upward-sloping portion of the original supply curve.
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Exhibit 5: Effect of a Unions Wage Floor


W
Labor per period
D
S
(a) Industry


W
Labor per period
s
d = Marginal
revenue product
(b) Firm
W
a
g
e

r
a
t
e

W
a
g
e

r
a
t
e



a
E''
W' W'
e'
s'
E' E e
Once this wage floor has been established, each firm faces a horizontal supply curve of
labor at the collectively bargained wage, W. Since the wage is now higher, the quantity of
labor demanded by each employer declines from e to e' as seen in the right panel.
The higher wage leads to a reduction in total employment as shown by the decline from E to E'
in the left panel. Each firm faces a horizontal supply curve of labor at the collectively
bargained wage quantity of labor demanded by each employer declines from e to e
25
Exhibit 5: Effect of a Unions Wage Floor


W
Labor per period
D
S
(a) Industry


W
Labor per period
s
d = Marginal
revenue product
(b) Firm
W
a
g
e

r
a
t
e

W
a
g
e

r
a
t
e



a
E''
W' W'
e'
s'
E' E e
At wage W, the amount of labor that workers would like to supply, E, exceeds the amount
demanded, E. In the absence of a union, this excess quantity of labor supplied would cause
unemployed workers to lower their asking wage. With a union, workers cannot offer to
work for less, nor can employers hire them at a lower wage.
Because of the excess quantity of labor supplied, the union must somehow ration available jobs,
such as awarding jobs based on worker seniority or connections with the union
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Effect of Union Wage Floor
With the inclusive, or industrial, union the
wage rate is higher and total employment lower
than would be in the absence of a union
Those who cannot find union employment will
look for jobs in the nonunion sector, causing
the nonunion wage to be driven downward
Wages are relatively higher in the union sector
for two reasons
Unions bargain for wage higher than the market-
clearing wage
Those unable to find employment in the union sector
crowd into the nonunion sector
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Exhibit 6 Median Weekly Earnings Are Higher
for Union Than Nonunion Workers
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Exhibit 7a: Effect of Reducing Labor Supply



A successful
supply
restriction
would be
shown as the
leftward shift
from S to S'.
29
Reducing Labor Supply



A successful supply restriction
Requires that the union:
limit its membership
force all employers in the industry to hire only
union members a craft union

Membership can be restricted with high initiation fees,
long apprenticeship periods, difficult qualification
exams, and other devices

Defended on the grounds that they protect the public
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Exhibit 7b: Effect of Increasing Labor Demand


Third way of
increasing wages is if
the union can somehow
increase the demand
for labor by causing
the demand curve to
shift from D to D
This is a more
attractive alternative
because it increases
both the level of
employment E to E''
and the wage rate W
to W' there is no need
to ration jobs among
union members
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Increasing the Demand for Labor
Increase demand for union-made goods
Restrict supply of nonunion-made goods
Increase productivity of union labor
Some claim that unions increase worker
productivity by minimizing conflicts, resolving
differences, and monitoring workers
If this is indeed true, the demand for union labor
should increase
Featherbedding
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Featherbedding
Union efforts to force employers to hire
more workers than wanted or needed
Does not create a true increase in the
demand, in the sense of shifting the demand
curve to the right
Instead, forces firms to hire more labor than
they really want or need, thus moving the
firm to a point to the right of its true labor
demand curve
33
Recent Trends in Union Membership
In 1955, about one-third of wage and salary
workers belonged to unions, now only one in
seven belongs to a union
Government workers make up nearly half of all
union members
Compared with other industrialized countries,
the U.S. ranks relatively low in terms of
unionization

34
Recent Trends in Union Membership
Union membership rates vary greatly across
states
Rates tend to be highest in the Northeast United
States and lowest in the South
Decline in union membership is due partly to
structural changes in the U.S. economy
Employment in the industrial sector has been
declining, and increasing in the service sector
Growth in foreign competition
Near disappearance of strikes
35
Exhibit 8 Unionization Rates by Age and
Gender