Combining the models to provide a stylized representation of wage ß oors

6.35. The modern theory of the labour market can be interpreted as viewing employment in a business as determined by the inter- action of the businesses’ labour demand with the maximum of four wage ßoors. These wage ßoors are discussed below.

Sources and implications of wage _ßoors

6.36. The Þrst case is the neoclassical model where the wage ßoor is the wage necessary to retain good employees and to attract employees from other businesses. This wage ßoor, which is set through competition with other businesses for labour, de- termines both the wage paid and the businesses’ employment. Figure 6.1 shows a stylized representation of this case for an individual business. Here, small changes in the level of the other wageßoors do not inßuence either the wage paid or the level of employment. If the other three wage ßoors are not binding in any of the other businesses with which this busi- ness competes for labour then that particular labour market is well approximated by the neoclassical model. Notice that in this case a business answering Q24a would respond that a guarantee of no change in the safety net for a period of Þve years would have no effect on their employment of labour. 6.37. For future reference we note that the aggregate labour demand

for an industry is obtained by taking the labour demand curves for each business and summing horizontally over all the busi- nesses. By summing horizontally we mean that a given wage is chosen and the labour demand for each business is obtained

4_{Don Harding’s Intermediate Macroeconomics lecture notes on the effi-}

ciency wage model set out a basic efficiency wage model that includes the interaction between efficiency wages and the tax and transfer sys- tem. The lecture notes are available from the authors on request.

Figure 6.1: Neoclassical model where the wage is determined through competition for employees with other businesses

Real wage

Employment Maximum of real

minimum award wage rate, real efficiency wage and real reservation wage.

Businesses labour demand curve for award employees

Existing employment Wage necessary to retain good employees and attract employees from other businesses

at that wage. The sum, over all businesses in the particular labour market, of all these individual labour demands, at that wage, yields a point on the aggregate labour demand curve. The process is repeated for different wage rates until the com- plete aggregate labour demand curve is obtained.

6.38. In Figure 6.1 there are three other wageßoors that are referred to. These comprise,

• The wage ßoor set by the Safety Net for the particular industry or occupation. We refer to this as the mini-

mum award wage rate.

• The e_fficiency wage.

• The reservation wage.

6.39. The second case is where the wage set by the Safety Net is currently above the maximum of the other wage ßoors and would remain in that position even if the Safety Net was not increased for Þve years. This case is shown in Figure 6.2. Businesses in this situation are those that would respond at Q24a that they would hire additional employees if a guarantee were given that the Safety Net would not be adjusted for a period ofÞve years and would respond at Q24f that they would not give these new employees a wage increase over the nextÞve years.

6.40. The third case is where the wage set by the Safety Net is cur- rently above the efficiency wage but after the Safety Net was

Figure 6.2: Case where minimum wage would remain the bind- ing constraint even if the Safety Net was not increased forÞve years Real wage Employment Existing real minimum award wage rate. Maximum of real efficiency wage and real reservation Real value of current nominal award wage rate after five years of inflation at 2.5 per cent per year.

Businesses labour demand curve for award employees

Existing employment

Employment under scenario of no safety net adjustment for five years

held constant for Þve years the efficiency wage would become binding. This case is illustrated in Figure 6.3. Businesses in this situation would respond at Q24a that they would hire ad- ditional employees if a guarantee were given that the Safety Net would not be adjusted for a period ofÞve years but would respond at Q24f that they would give these new employees wage increases over the next Þve years. These wage increases would come into play when the efficiency wage became bind- ing.

6.41. The fourth case to consider is where the efficiency wage is the binding ßoor that determines the businesses employment. This case is shown in Figure 6.4. In this situation the business will respond at Q24a that under a guarantee of no change in the Safety Net they would not hire any additional employees because the wage set by the Safety Net is not the binding constraint that prevents their business from employing more people.

Monopsony

6.42. Monopsony arises where the wage paid by the business varies with the quantity of labour it uses. This is shown in Fig- ure 6.5 by an upward sloping labour supply curve. Thus, the monopsony case is very different to the other cases illustrated in Figures 6.1 to 6.4 where the wage paid by the business does not depend on the quantity of labour used by the business. In

Figure 6.3: Case where the wage set by the Safety Net is binding now but after Þve years of no change in the Safety Net the efficiency wage would be binding

Real wage Employment Existing real minimum award wage rate Efficiency wage Real value of current nominal award wage rate after five years of inflation at 2.5 per cent per year.

Businesses labour demand curve for award employees

Existing employment

Employment under scenario of no safety net adjustment for five years

Figure 6.4: Case where efficiency wage is currently binding and wage set by Safety Net is never binding

Real wage Employment Existing real minimum award wage rate Efficiency wage Real value of current nominal award wage rate after five years of inflation at 2.5 per cent per year.

Businesses labour demand curve for award employees

Existing employment Over award payment

the monopsony case the labour supply curve is upward sloping for two reasons only. The Þrst reason is that the labour force in that market has different reservation wages. The second reason is that for each member of the labour force the wage required to obtain an additional unit of labour is increasing in the quantity of labour supplied. This reßects the standard assumption made in all analysis of the labour market that the marginal disutility of labour is non decreasing. The labour supply curve is the horizontal sum of the labour supply curves of the individual workers.

Figure 6.5: Monopsony Real wage Employment Value of marginal product of labour at employment level consistent with monopsony wage

Real wage set by monopsonist

Businesses' labour demand curve

Employment level consistent with monopsony wage Wage under free

entry

Monopsonist's profits

Supply of labour to monopsonist Monopsonist's marginal expenditure

on labour

Employment level under free entry

6.43. Under monopsony the fact that the labour supply curve is up- ward sloping means that each time the monopsonist hires an additional worker the higher wage must be paid to all of the existing employees. Thus the monopsonists’ marginal expen- diture on labour is always above its average expenditure on labour as measured by the labour supply curve. The monop- sonist’s labour demand curve is equal to the value of the mar- ginal product of labour. The monopsonist optimally chooses the level of employment that maximizes its proÞts. This oc- curs where the monopsonist’s marginal expenditure on labour is equal to the value of the marginal product of labour. The wage paid by the monopsonist is then obtained from the labour supply curve faced by the monopsonist. The monopsonist ob- tains a proÞt that is equal to the product of the difference between the value of the marginal product of labour and the wage paid with the monopsonist’s employment. Such proÞts would in the normal course of events attract other businesses to enter, to compete for labour with the monopsonist. If entry

is completely unrestricted then it will drive the wage up to the competitive wage where the labour demand curve inter- sects with the labour demand curve thereby eliminating the monopsonist’s proÞts.