Unit 9 Summary | Core Econ | The Economy Textbook PDF

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Summary

This is a summary essay outlining three main questions from the book chapter outlined in the name of the file....

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Questions: 

How have incomplete contracts impacted the wage setting process?

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To what extent is the price setting curve efficient?

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Under what circumstances the price and wage setting curves be shifted?

Learning Objectives: 

Evaluating the price setting curve and the process in which it is set.

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Discussing the different scenarios that shift the price and wage setting curves and understanding the effects thereof on different stakeholders.

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Understanding the different determinants of the price and wage setting curves

The process of hiring a worker, allotting a wage, and reaping the benefits of their output is one that is onerous and lengthy. For all parties involved, there are many steps that must be taken with heed as there is a lot on the line. For the firms, they aim to always maximise profit. As profit (in this simplistic view of the labour market) is calculated by difference between the revenue and the labour costs, the process of profit maximisation is done by lowering the wages as low as possible. However, as discussed in later arguments, wages cannot simply be set at the mere whims of the employer. Instead, there is an arduous process that goes into finding an equilibrium wage between the two stakeholders: the firms and the employees. In a perfect world, the entire expectation of the firm from an employee is detailed in the contract. This would mean that a quantifiable output is required to complete the requirements of every workday which then translates to a certain wage. This would mean that all employees would be motivated to completing the assigned work in order to retain their wages and overall productivity would be set by the firms. However, the real world is seldom so black and white. It is often impossible to outline certain contingencies and quantify output. For example, in professions such as working at a restaurant, an employee’s output is largely dependent on exogenous factors that might not be in his/her control. Whether it is how many customers come into the restaurant on a given day or how much effort is required on a given dish, it is extremely difficult to quantify the output of this employee. As a result, we are left with the phenomenon of incomplete contracts which are based on the hours worked per day and not the output the employee is able to provide. As a result, we are forced to ask the question: How have incomplete contracts impacted the wage setting process? This question is quite complex, and it is important to understand why there is an impact in the first place. As mentioned earlier, the idea of incomplete wages is one that leaves a lot of room for economic efficiency. Many workers are paid too much considering their incompetence and lack of output, while many others are paid too less for the

amount of output they produce. Furthermore, due to a lack of structured requirement per worker in many professions, they are often not incentivised enough to work at their maximum capacity. We are left with a Pareto inefficient world in which all parties could have produced more. Therefore, the presence of incomplete contracts meant that there must be quantifiable ways to ensure productivity and avoid complacency in the workplace. Finding this equilibrium between the price setting curve and the wage setting curve is often like threading a needle as it is quite a strenuous process to make sure all parties are satisfied with the final equilibrium. At its base, an incomplete contract makes it difficult to incentivise an employee to work at capacity. Therefore, a firm must devise a wage that is high enough to warrant hard work but not too high to warrant complacency. The wage can also be altered by the level of unemployment in the nation. For example, if unemployment is particularly high at a certain time, the firm has higher bargaining power as it is unlikely that workers can find other jobs. As a result, they can offer lower wages and still have workers remain employed as the employment rent is simply too high. As a result of incomplete contracts, firms often provide other benefits such as health insurance to employees to further incentivise employment at their firm. It has been proven time and time again, that happy workers with loyalty to their firm are often the most productive and efficient. The aforementioned system of deciding a wage is a simplistic one. In reality, it is a process that goes through multiple different parties within and outside a firm. On its face value, the wage is a mere value. However, it is actually the equilibrium between the wage and price setting curve. The wage setting curve is set by the firm and is based on the nominal wage, the amount of output and the total employment that the firm requires. This is then followed by the drawing of a price setting curve that is based on the wants and needs of the employees. However, since all the stakeholders are working in a self-interested manner, we are often left with a lack of efficiency in the price setting curve. Therefore, we must ask: To what extent is the price setting curve efficient? To be able to truly judge the efficiency of the price setting curve, it is important to understand the different stakeholders that impact its decision. One of the main factors in deciding the price setting curve is the presence of a labour union. In many countries, the labour union is driving force in providing fair wages for all workers. However, at the threat of strike, labour unions are sometimes able to extract more wages from firms than are fair. This leads to many workers to be complacent since they are aware of the power of labour unions. However, on the other hand, countries like Estonia with low labour union density and low collective bargaining coverage, workers are often underpaid or given exuberant numbers under the guise of nominal wages. Especially in the case of blue collar

jobs, a lack of education and understanding of inflation leads many workers to be happy with slight pay rises every now and then when in reality, the wages are growing slower than the average price level of the economy. While labour unions might sometimes promote inefficiency in wage distribution, it is also true that being a part of a labour union and having their voice heard often helps in making a job to feel less onerous for the employee, thus making them more satisfied with their job and more likely to work hard (union voice effect). Due to the cutthroat nature of capitalist economies, it is unfair to single out labour unions for trying to extract more pay than is fair or firms for doing their best to provide the least pay they can. As a result, we are often left with a contentious compromise. With a basic understanding of how these wages are decided and how it impacts the different stakeholders, we also must know what are the different determinants that might cause a shift in these curves. Under what circumstances the price and wage setting curves be shifted? The price and wage setting curves are ones that move subject to a fair bit of movement. In the case of the price setting curve, there are many macroeconomic trends that can define movements. In the case of emerging economies like China, education has become better in quality and a lot more prevalent and accessible. As a result, employees are more skilled by the time they reach the working age. This means that the overall labour force is systemically becoming more productive which also leads to an upward shift in the price setting curve. Due to this, many companies are looking to other developing economies such as India and Bangladesh as China is no longer seen as the only hub for cheap labour. This is the same with employment specific training as it increases the productivity of the labour force. On the other hand, the government often provides wage subsidies. This means that price setting curve is lowered by the amount of subsidy that is granted. These are changes that occur quite often. However, in the case of the wage setting curve, the only real determinant is unemployment benefits. If these are lowered, the reservation wage is also lowered, thus bringing the curve down too. In general, the labour market is quite a controversial one. Especially in the case of developing economies, workers are exploited for low pay. This cycle is also one that is very difficult to break out of as unemployment is high in these economies meaning that the employment rent is also quite high. The resulting labour market is one that is unfair and inefficient, yet the workers must remain employed to make ends meet. The only way to break out of this is to promote education, and work towards widespread economic development. Unfortunately, that is a lot easier said than done. However, as we have seen countries like

China gain higher average wages and better working conditions, it is with hope that economists predict that a similar effect will be observed in other developing economies with time.

Works Cited: The Economy – Core Economics (https://www.core-econ.org)...