Theories of Wage and Employment in The Labour Market

Theories of Wage and
Employment in The Labour

Market
Labour Economics 3249
LABOUR MARKET ECONOMICS
Submitted By: Lewis Morra

Submitted To: John Beare
T.A.: Jeff Quattrociocchi
Date Submitted: Friday, June 20, 2014
Lewis Morra
John Beare
Sep 25, 16, 19:34 A9/P9
Theories of Wage and

Employment in The Labour
Market
Labour Economics Research Paper
Throughout the years in our society, there have been many changes
implemented in the ways in which producers and consumers govern
themselves in our markets. From free slave labour, to relativized
compensated wage labour, there have been numerous industrialized
changes world wide. Wages and even money in general, has become
something of vast importance each passing year and as a society, we have
structured levels of methods devising how to acquire and diversify wealth in
our economy in more ways than ever before. Fundamental structuring such
as education and designative instructive courses have become not only
beneficial, but necessary for people to gain entry in the labour market and
surpass the boundaries of minimum wage lifestyles, which is to be discussed.

Increasing levels of education and experience will increase possibilities, from
productivity to return on investment, and will grant an employer reason to
implement efficiency wages. These types of wages granted to higher skilled
employees are necessary for a firm to prosper by means of; discouraging
shirking (in other words making it more costly to be fired), encouraging
worker loyalty to the company, raising group output standards and finally,
raising morale in a workplace. With this being said, it is easily notable how
higher wages can encourage one to be more efficient and allocate even
minimal resources to achieve higher productivity in a company, but what
about lower wages? A decrease in wages will do the exact opposite, and in
close relation, wage deflation will prove how underpaying efficient workers
can lead to consequences and downfalls in a firm. Wage deflation can be
directly related to underpaying employees because it is a form of under
compensation, whereas an employee by means of experience and training is
worth more, but under valued. Wage deflation occurs when wage
compensation to an employee is not kept up with economic inflation which
usually occurs at times of stagnant economic times such as a recession or
times of lack of economic growth (economic troughs in a business cycle
graph). Another instance wage deflation may occur is when a technology is
introduced that could ultimately take over part of someones job.
Technologies over the years through industrialization have been invented
and implemented into our economy to push higher volumes of outputs in
firms and decrease manufacturing and labour costs, so although this can be
detrimental to an employee, it is deemed high regard for producers to
implement such technologies. By means of advancements in technologies,
firms are able to create product innovation and increase quantities, while
simultaneously decreasing production costs. At this time, firms will see
prosperous gains and higher Production Possibility Frontiers (PPFs), which is
prevalent in our growing society. Producers are able to attain higher gains
because these new technologies yield better techniques which in turn leads
to higher obtained efficiency, also the decrease in labour costs may allow a
firm to expand production, thus grow in a economy. With this being said, it
can be noted that with the increase in implemented use of technology,
producers now will see less need to hire more skilled workers and will be
more influenced to hire cheaper labour such as minimum wage, unskilled
labourers.
In the past, and to
some extent today, the
means for living and for
procuring the services of
others was not primarily
through a system of wage
payment. - Theory of Wages,
Florence Peterson
The time where money
was not a means of currency is over. One could in fact live and work without
the process of money transaction by means of producing his/her own goods
and commodity and even in a surplus to trade or barter, but since modern
society is infested with greed and gluttony, making a living for the sake of
survival has also become a notion not too popularized to this day, and this is
why human capital strive to attain the highest amount of wealth and highest
possible utility. As previously mentioned, there has to be diversity in an
economy where a new idea of class is modernized, moulding a society into
sections and creating division in inevitable. Diversity presents itself in the
work force mainly as skilled and unskilled labour capital, and with the
implemented new growth of firms via use of technology, a bigger diverse
society can be witnessed as this phenomenon excels. Fewer people will
control more wealth and more will be unskilled as this division widens with
the emergence of a new aged competitive, capitalistic society.
Wage theories in a noncompetitive economy, such as state capitalism

or communal socialism, would of course be based upon entirely different
concepts. In a free capitalistic economy, wages represent the payment of
one of the factors involved in production. Since the problem turns on the
question of the sharing of distribution of the goal income derived from
productive enterprises, theories of wages cannot be dissociated from the
other factors of production. - Theory of Wages, Florence Peterson
It is now witnessed how an economy is governed by naturalistic
ideologies to acquire wealth and obtain the highest value of commodity to
match their greedy utility, but it is yet to be discussed how these values
intertwine in a competitive society with further structure. Wage rates,
experience, and employment are factors in determining division of labour
and will soon be investigated. In a market where there are many firms to
produce and many consumers to purchase, there are natural rules that
govern methods to buy and sell. Natural rules such as the ones previously
mentioned, where producers want to sell efficiently; and buyers want to buy
efficiency, both in terms of saving money and gaining more. This makes for
a competitive market where the supply of labour in terms of wages to
produce and prices to sell are set by the economy. In contrast, the demand
is set by the prices which are also set by the economy. This makes earning
exceptional amounts of money and becoming very wealthy, more difficult.
First, a topic of monopolies and monopsonies (monopoly for labour) can be
discussed, whereas there are not many firms so the monopsonist will be the
one to set the wage rate as he sees fit. There is a contrast for the many
dissimilarities in this type of labour market, for instance in this market the
supply of labour is not equal to the marginal cost of labour like it is in a
perfectly competitive market, this is because to increase labour by 1
additional unit in a monopsony, the cost isn't just higher for the 1 extra unit
of labour, but an additional increase in wage for the previous worker.
In this type of situation where a monopsony is present, the producer of

the firm will hire at MCL = MRPL, where the marginal cost of labour is equal
to the marginal product of that additional unit of labour. This would not be
the case in a competitive market, nor is the firm in this scenario paying the
employee a wage rate of denoted MRPL(w), in this particular case the firm is
hiring at Eq, but paying the employee a wage of Wq(w), since the labourer is
willing to work for the said wage (Wq) on the labour supply average cost
curve on the graph (ACL). The monopsonist is able to do this because even
though the worker is valued more where MCL = MRPL, they are willing to
work for a lesser wage. In relation to a perfectly competitive market where
labour capital has a choice of where to work, a firm in perfect competition
will hire where the demand for an additional worker is met by the supply in
terms of average cost of labour - ACL = MRPL. At this intersection, wage
rates and the quantity of labour employed are both higher than that of the
scenario where monopsony was in effect. As can be shown, there is a vast
difference in terms of wages and employment in perfect and imperfect
labour markets. There exists no sensible relationship between a producer in

a monopolistic or monopsonistic economy, and the quantity demanded of
labour at the existing economic wage rate; this can be reassured noticing
that the monopsonistic labour purchaser does not yield a short run labour
demand curve. With this monopsony in place, it is possible to implement a
minimum wage rate in such a scenario that a benefit to labourers in the firm
and workers in the economy can be noted. In this case for example, a union
minimum wage rate is denoted by min w, much above the monopsony
wage Wq, and just above the competitive market equilibrium given by comp
w. In this case, labour supply denoted by C, exceeds that of the labour
demanded on the MRPL schedule at point A. This makes the new average
cost of labour curve, minWCACL, since the firm cannot hire below the
minimum wage rate below point C.
Now that a brief description of wage rates in a monopsony verses a

perfectly competitive market has been presented, it is viable to take note
back to previous discussion on factors in determining labour and wages. It
was a great man who quoted,
A man educated at the expense of much labour and timemay be
compared to oneexpensive machineThe work which he learns to
performover and above the usual wages of common labour will replace the
whole expense of his education. - Adam Smith
Adam Smith attests to previous notion that education is a form of
investment in which labourers will expend time, resources and effort into to
become more efficient, knowledgeable and more capable of commanding
such jobs that requires more skill and in turn, will be compensated for such
skills in the form of higher wages. This theory can be viewed evident in a
CobWeb Model - initially originated by Nicholas Kaldor - where periodic
fluctuations are represented on a graph to show future expectations with

present determinants (such as levels of education and experience).
As shown in the graph above in A, there are 2 demand curves for labour.
First, a type of lesser skilled labour and another for higher skilled labour via
education and training, represented by D1 and D2 respectively. To maximize
efficiency and thus output in a firm, a company will demand higher skilled
human capital to thrive. As shown above, to attain higher and more skilled
human capital, that firm will have to pay a higher wage which can be shown
by the vertical leap from W1 to W2 on graph A. The straight vertical leap
from W1 to W2 can only be witnessed because there is a short run supply of
labour denoted L on the graph as inelastic, and the reason for this is because
in the short run, an operator of a firm cannot instantaneously gain extra
human capital. In order for this to happen, it takes time and resources to
train and hire more workers. It isn't until time passes in the long run where a
change in the graph can be viewed, such as in graph B where we see a
horizontal shift towards the long run supply curve S. This is only attainable
because in the long run, an employer has the opportunity to train and hire
new workers at that higher wage rate, which is why there is also a shift in
quantity of labour supplied from L to L2. Further down the road, the
company will likely operate in equilibrium whereas in this scenario, wages
will decrease because workers are getting overpaid for D2 levels of skill, and
at that slightly lower wage rate, less skilled labourers will be willing to work
for lower wages - this will remain true until the demand for more skilled
labour equals the long run supply.
To return to the relatable ideologies of Adam Smith, we can now hold

true his notion that education is a form of investment in time, but now a new
question will arise regarding the amount of time and when time invested into
furthering education is too much time invested. Time is the most valuable
resource an individual can possess, one may choose to allocate time as a
resource in exchange for consumption or leisure, but cannot acquire
additional time. This is because individuals have a life span, and are faced
with decisions on how to spend their life span in the market, either in the
labour force or not, employed or unemployed; and if unemployed, without a
job but actively seeking work. Individuals are also faced with decisions prior
to entering the labour force, such as how much time to allocate to
developing skills via educational institutions and how much money to invest
in it as well. These can be seen as direct costs, whereas indirect costs may
refer to the opportunity costs of investing time into gaining experience, in
other words the money forgone and unattained from entering the work force
later instead of earning wages sooner in direct exchange for time spent.
However to analyze this idea and see how much time an individual should
spend in training, it is best to first witness how these costs are interpreted in
the study of economics. In the graph below - presented by David Sapsford;
professor of Economics, University of Lancaster - it is shown how an
individual would undergo direct and indirect costs of expanding education to
later on inherit the benefits.
Prior to joining the labour force at age 21 on the graph, an individual
would train from age 18 to 21, and incur costs equaling X and Y, where X is
the opportunity cost foregone by wages he or she could have earned, had
they entered the work force at age 18 and skipped education. The
10
real question would now be, how much time in terms of years would the
labourer in this scenario have to work to make up for the direct and indirect
costs of inheriting the benefits, Wt - Ws, in the labour market. An individual
seeking to further education will incur direct and indirect loss in terms of
costs as indicated in the graph above, but what is not shown is the years of
education relating to marginal costs and marginal benefits. In deciding how
many years of time to allocate to become more skilled and ultimately earn a
higher wage rate in the labour force, an individual will gain education where
the extra benefit, or marginal benefit of each extra year of studying (MB), will
equal the extra costs, or marginal costs of each extra year (MC). In this case,
marginal benefit is viewed in terms of the marginal amount of wage rate
annually that person will make in the work force, similarly the marginal cost
is the marginal time, indirect and direct marginal costs combined, that the
person will lose annually. With this said, it is apparent that the marginal
costs of education will be an upward sloping curve, and the marginal benefits
of education will be downward sloping on a graph with the value of marginal
benefits and marginal costs on the Y-axis, and years of education on the Xaxis. This is because as people tend to stay in the education system longer,
education becomes more expensive with each passing year, from high school
11
to undergraduate studies, and post graduate studies respectively. With this

being said, it is also apparent that the benefits of staying in the education
system
longer
possess diminishing returns since the costs of gains of having more

education will start to outweigh the benefits. Another way of looking at this
is to view the combined marginal costs and marginal benefits in terms of
internal rate of return, and compare it to the market interest rates (money
that could be spent earning bank interest as an opportunity cost). In this
case, it is best for an individual to achieve years of education at the point
where there internal rate of return equals the market interest rate. A perfect
brief description of this optimal selection can be read in the course text on
page 248,
Individuals choose the human capital investment that maximizes the
net present value of lifetime earningsAlternatively, the individual could
12
calculate the implicit (or internal) rate of return i for each level of education,
corresponding to the discount rate that yields a net present value of zero for
the investmentthe individual should invest until the internal rate of return
equals the opportunity cost of the investment, given by the interest rate. Labor Market Economics, pg248
In certain circumstances, there lies a scenario in which the employer will
aide in providing financial support for the direct costs of increasing skill in
the firm while the employee is hired. For example, a chartered financial
analyst working for a federal corporation will have to achieve his or her CFA
designative courses for the assigned position. If at the time of hire or even
afterwards, the employer notices only a first level designation, that employer
will pay half of the direct cost for the new employee to study their level 2
and eventually level 3 designations to increase skill and be a more efficient
worker in the firm. In the long run, both the employee and employer will
share benefits in this cooperation, the employer will gain more skill from the
employee without having to hire additional labour, and the employee will
enjoy a higher wage rate without having to get another job or twilit to
perhaps generate the same income. In a separate case, it has been shown
in times where an individual after allocating time and resources to expand
their possibilities frontier, will willingly remain unemployed. There are more
than a few reasons for this outcome to arise. This type of unemployment also called voluntary unemployment - remains viable in situations where
the skilled labourer deems him or herself more valuable, and purposely
remains unemployed in search for a higher wage paying position rather than
to settle with what is currently being offered at the time. A similar yet
contrasted experience can be noticed in cases where the ruling for a
particular position in terms of wages offered, is higher than the economic set
equilibrium wage rate. In this case there will be an excess supply of labour
in the market for such a particular position and an over labour demand - this
is the case where an individual in the labour force will be involuntarily
13
unemployed. In this case, the skilled labourer will want the job offered and
attempt to gain the position, but since there is an under demand for the job
because the wages are set higher than equilibrium and there is an over
supply for the same reason, this individuals chances of getting that job are
smaller. There lies a theory connected to this idea that participation in the
labour force will increase in a given economy, when unemployment rates are
on the rise. For example, in a family where only the man of the household is
working, he might experience a time in his life where hours are cut or he is
laid off or even fired from his job. At this point in time to supplement income
for the family, a family member such as the wife or child may join the labour
force to help pay for bills and increase overall net income for the family,
which is known as the added worker hypothesis. This also holds true for a
circumstance of discouraged workers. In times where there is a decline in
GDP in an economy and wealth is stagnant, jobs become harder to obtain
and the supply of labour eventual exceeds the demand. An individual
striving to search for a job may start to settle in the short run when seeking
employment, and take a job he or she is overqualified for with a lower wage
rate, and if the individual does not settle, that person might become
discouraged and want to leave the workforce altogether and stop any
attempts in searching for a job - which is known in economics at the
discouraged worker hypothesis. This directly impacts a survey of
unemployment, because a new term hidden unemployment would be used
to describe such human characteristics in an economy. To describe this more
clearly, hidden unemployment refers to those who are not necessarily in the
labour force, but would be if finding a job would be easier or more readily
obtainable at the time.
Theories on how to allocate time to train for a job and participate in the
labour market have been discussed; decisions on weather to join the labour
market or not have also been addressed, one subject is to be noted on what
decisions to make as an employee once a job has been obtained. As
mentioned earlier, an employee in the labour market is faced with choices,
14
and the biggest choice employees make when in the labour force, is how to
allocate time as vital resource (so many hours to work), which in turn will
lead to income. In economic theory, it is proper to state first that all income
(again theoretically) will be spent on consumption in the economy (for
cyclical purposes), the result: the Income-Leisure model. This model directly
shows how an employee as a consumer in the market, would make choices
by use of personal utility, and would directly compare amount of personal
consumption to personal leisure. This model becomes very useful for
employers because it demonstrates how changes in wealth, determine the
cause and effect reaction of an employees optimal choices in allocating
time. In this drawn graph below, it can be shown how an individual might
allocate
time to
leisure or
income
(consumption) and how increases in wage might alter preference of

consumption of good and leisure.
15
The consumer has initial choices along X1 and Y1 to work more and
have less leisure. In this case, at a wage rate -Y1/X1, the consumer has
choices to either spend all his his or her time working and is then able to
achieve Y1 amount of income for consumption, or this person may not work
at all and allocate all of his or her time doing leisurely activities and
producing 0 income at X1 amount of leisure. Since the employee has an
indifference curve pertaining to the X1,Y1 income leisure curve, this person
will operate at optimal point A and work X1-T1 hours and make YA income.
This individual will operate where the wage rate -Y1/X1 equals the slope of
his/her indifference curve at point A, which is his individual marginal rate of
substitution. An employee in the labour force may also have preferences as
noted earlier, these preferences are followed by effects from the choices the
labourer may have, in this case it is evident to study the case of a increase in
wage and the following income and substitution effects that may arise from
it. In the graph above, the slope increase from Y1,X1 to X1, Y2, is displayed
as a wage increase (higher negative slope). With a higher wage rate, a
16
consumer is now able to achieve a higher income, thus is also able to spend
more money and ultimately consume more goods (since in this theoretical
scenario, all income must lead to consumption). With the ability to consume
more goods, a consumer will face 2 decisions of wether to work more and
take advantage of the higher wage rate, or work less because he/she is able
to still consume the same or even more, also with more leisure.
When the X1,Y1 curve becomes more steep on the graph with the higher
wage rate, and becomes X1,Y2, a steeper curve implies a bigger loss in each
increment of income represented by the Y-axis when moving down the curve
for each marginal increment gained in leisure represented by the X-axis. In
said situation, a substitution effect is noted and the consumer will now reside
at point C on the curve, with less leisure X1-T0, and more income because
consumption is now valued to the consumer more. The second choice a
consumer may make is to work less since he or she will still remain more
satisfied because they able to afford more goods without having to work
more and even working less. As we can see on the graph, this consumer
values leisure higher and will not work more even with a higher wage rate point denoted by B on the graph.
Many topics have been addressed briefly in terms of different theories
witnessed and implemented in various economics. From the wages an
employer might choose to hire at or grant such as efficiency wages, to
market wages such as in competitive markets models and how wage
deflation can alter the market. Industrialization and how the implementation
of new technologies of various sorts can shape the decisions firms will make
and also change the structure, allowing higher production of commodity and
the ability to hire less skilled workers, and still be more efficient. From this
theory stemmed discussion on the birth of capitalism and how society has
reached an age where money is prevalent and making money for the sake of
living has become an idea of the past. Following this, the realization that an
economy with a monopolistic and/or monopsonistic business will price
discriminate and hire under the valued wage rate to save money and raise
17
utility which is a motion of a capitalistic firm, which also in tern led for the
emergence of discouraged labour theories. These stem from firms not hiring
at the proper valued wage rates, which will lead to individuals actively
seeking jobs, feeling discouraged and under valued in the economy, and also
reside to hidden unemployment status. Theories of education were noted
where an individual in would have to make choices prior to entering the
labour market, these in regards to education and the length of time, when
and for how long to gain skill in educational institutions, and finally, touched
on the topic of how to allocate time as a resource once employed in the
labour market. There are many theories regarding wage and employment in
the labour market, these investigated are only a few intertwined with each
other, some never changing as they portray the foundational structure of
human ideology, and some changing with the always-changing economy.
18
Work Cited
-Benjamin, Dwayne and Morley Gunderson. Labour Merket Economics,
Theory, Evidence, and Policy in Canada, seventh edition. Library and
Archives Canada Cataloguing in Publication. 2012
-R. Varian, Hal. Intermediate Microeconomics, a Modern Approach, eight
edition. Jack Repcheck. W.W. Norton & Company. New York. London. 2010
-E. Kaufman, Bruce. The Economics of Labour Markets, third edition. Jan
Richardson, Karen Vertovec. 1991
-Sapsford, David and Zafiris Tzannatos. The Economics of the Labour
Market. St. Martins Press New York. 1993
-Krader, Lawrence. Labor & Value. Cyril Levitt & Rod Hay. Peter Lang
Publishing, New York. 2003
-Peterson, Florence. Survey of Labour Economics. Revised Edition.
Harper & Brothers Publishers New York. 1951
-Kay, Geoffrey. The Economic Theory of Working Class. The Macmillan
Press Ltd. 1979
-Krimpas, G. E. Labour Input and the Theory of the Labour Market.
Gerald Duckworth & Co. Ltd. 1975
Also used as reference;
www.economics.about.com - Efficiency Wages
19
http://cstl-hcb.semo.edu - business cycle graph

http://tutor2u.net/economics - Monopsony information and graph aide
http://www.econ.ucsb.edu - Leisure Income Graph Aide
http://www.investopedia.com/articles/economics - CobWeb Graph
20

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Theories of Wage and

Employment in The Labour

Labour Economics 3249

LABOUR MARKET ECONOMICS

Submitted By: Lewis Morra