1. Chapter 12
Labor Markets and Unions

2. Labor Supply and Utility Maximization
• Two sources of utility are important:
– The consumption of goods and services
– The enjoyment of leisure
• It is a normal good
• The more leisure time you have, the less you value an
additional hour of it

3. Three Uses of Time
• Market work- selling your time in the labor
market
– Your time becomes your employer’s time
• Non-market work- your time is used to
produce your own goods and services.
– Laundry
– Cooking
– Cleaning
– Mowing

4. Three Uses of Time
• Leisure- using your time in non-work pursuits.
– Movies
– Dinner with friends and family
– Hobbies

5. Work and Utility
• Disutility: the opposite of utility
– Sadness or pain
• Increasing marginal disutility: the more you
work, the greater the marginal disutility of
working another house.
– There is always something you do not enjoy about
working.

6. Utility Maximization
• You attempt to maximize utility by allocating
your time so that the expected marginal utility
of the last unit of time spent in each activity is
identical.
– Expected marginal utility of the last hour of
leisure= expected marginal utility of the last hour
of market work= expected marginal utility of non-
market work

7. Implications
• The higher your market wage, the higher your
opportunity cost of leisure and nonmarket
wage, OTHC.
– Why do corporate lawyers live downtown?

8. What are you planning on doing this
What are you planning on doing this
summer?
summer?

9. Substitution and Income Effects
• An increase in the wage has two effects on
your use of time.
– Substitution Effect
• Substitute market work for other activities
– Income Effect
• At a higher wage, you are willing to have more leisure

10. Substitution and Income Effect
• As the wage increases, the substitution effect
causes you to work more, but the income
effect causes you to work less and demand
more leisure.

11. Backward-Bending Labor Supply Curve
• It slopes upward until a specific wage, then it
bends backward above that wage.
– The reasoning is once you reach a wage above
that level you incentive structure changes and
now you can work less and earn the same
amount.

12. Backward-Bending Labor Supply Curve
• The curve is shape this way because the
income effect dominates the substitution
effect.
– Evidences for this relationship in high earners.
– The assumption made is that workers have some
control over the number of hours they work.

13. Nonwage Determinants of Labor
Supply
• Other Sources of Income
• Nonmonetary Factors
• The Value of Job Experience
• Taste for Work

14. Why Wages Differ
• Training
• Education
• Age
• Experience

15. LO2 Exhibit 3
Average Hourly Wage by Occupation, U.S, May 2007

16. LO2 Exhibit 4
Age, Education, and Pay

17. Differences in Ability
• Winner take all labor markets: markets in
which a few key employees critical to the
overall success of an enterprise are richly
rewarded.
– Sports
– Music
– Acting

18. Differences in Risk
• If the industry is dangerous, then the pay is
generally higher
– Ex: the miners in Chile
– Construction

19. Types of Unions
• Labor Union: a group of workers who join
together to improve their terms of
employment
– They date back to early days of national
independence
• Craft Union: Formed in 1886, a union whose
members have a particular skill or work at a
particular craft
• Industrial Union: A union of both skilled and
unskilled workers from a particular industry.

20. Collective Bargaining
• Collective bargaining is the process by which
representative of union and management
negotiate a mutually agreeable contract
specifying wages, employee benefits, and
working conditions.
– Goes before membership for a vote
– If rejected the union can strike or can continue
negotiations

21. Mediation
• If negotiations reach an impasse, government
officials may ask an independent mediator to
step in.
• The mediator is an impartial observer who
listens to each side separately and then
suggests a resolution.
• If each side is still open to a settlement, the
mediator brings them together to work out a
contract.

22. Binding arbitration
• This happens in sections where a strike could
harm the public interest, such as police or fire.
– A neutral third party issues a ruling that both sides
must accept.

23. The Strike
• This is a major source of union power
• The union’s attempt to stop production to get
their workers the best contract.
• They are risky
– No pay
– No benefits

24. Problems with Unions
• The Union will negotiate a higher wage for
their members, so each firm will hire less
labor.
– This applies a reduction in employment (higher
unemployment in the industry)

25. LO4 Exhibit 5
Effects of Labor Union’s Wage Floor
(a) Industry (b) Firm
S
a
W’ W’ s’
Wage rate
Wage rate
W W s
d=Marginal
D revenue product
Labor Labor
0 E’ E E’’ 0 e’ e
per period per period
No union: market wage is W. Each firm can hire as much labor as it wants. The firm hires more
labor until MRP=W: e units of labor; industry employment is E.
Union negotiates wage W’, above the market wage W; the supply curve facing the firm shifts
up from s to s’. Each firm hires less labor, e’; industry employment falls to E’; excess quantity of
labor supplied = E’’-E’.

26. Reducing Labor Supply
• How do they increase wages while avoiding an
excess supply of labor supplied?
– They reduce the supply of labor by limiting the
membership to the union
• Increasing the fees to join the union (membership fee
was $50, it is now $125)
• Longer apprenticeship
• Tougher qualification exams
• More restrictive licensing requirements

27. Increasing Demand for Union Labor
• Increase demand for union-made goods
– Special Interest Groups
• Restrict supply of nonunion-made goods
– Example: Tariffs on Foreign Steel
• Increase productivity of union labor
– Quit rates are lower under unions, implying less
re-training

28. LO4 Exhibit 5
Effects of Labor Union’s Wage Floor
(a) Industry (b) Firm
S
a
W’ W’ s’
Wage rate
Wage rate
W W s
d=Marginal
D revenue product
Labor Labor
0 E’ E E’’ 0 e’ e
per period per period
No union: market wage is W. Each firm can hire as much labor as it wants. The firm hires more
labor until MRP=W: e units of labor; industry employment is E.
Union negotiates wage W’, above the market wage W; the supply curve facing the firm shifts
up from s to s’. Each firm hires less labor, e’; industry employment falls to E’; excess quantity of
labor supplied = E’’-E’.

29. Featherbedding
• They hire more employers than are needed
• The union attempts to dictate not only the
wage but also the quantity that must be hired
at that wage, thereby moving employers to
the right of their labor demand curve.