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1 ECON210 [2014]

ECON210 – Labour Economics How labour differs • Labour market = market for workers, who differ from in both structure and characteristics due to being human. • In product markets basic commodities are owned and can be exchanged between buyers and sellers; neither party has a personal interest in the product in terms of such aspects as age, sex, religion, race or personality and the product has no preference for price or market • Long term relationships in labour markets has reduced the ability of changes in wages to affect demand and supply  labour market less flexible and has less mobility of factors  prices in commodity markets adjust more quickly than labour markets in especially the downward direction • Unlike commodities which are largely homogenous and the decision to purchase determined by price, no unit of labour is identical to another, with a single unit’s productivity changing on a potentially daily basis due to such factors as: o Age o Gender o Race o Physical and mental capacities o Education o Experience o Motivation to work o Relationships with management and colleagues Thus each worker is an individual product with an individual demand and supply = complex market which best functions through the use of individual contracts based on one’s performance • Poses a challenge to employers, whose imperfect knowledge of labour units means that they cannot gauge individual worth. The price paid tends to be the relative value of the workers a group, in which qualifications and/or experience increase this price due to their generally creating, more productive workers = some individuals being overpaid while others are underpaid, for their contributions • The compositions of markets themselves can change also, in which the mobility of the suppliers of labour (employees) can occur as a result of changes in wages, working conditions and individual preferences Demand for labour • Price of labour determined by the interaction of demand for labour and supply of labour • Labour demand is a derived demand  demand for a productive resource, which is derived from the demand for the foods and services produced by the resource eg. A lack of students wishing to study economics would reduce the demand for economics teachers • The productivity of the labour also determines demand  marginal revenue product (MRP) = change in total revenue that results from employing one more unit of labour, whose increasing quantity will eventually diminish MRP = diminishing marginal revenue product

2 ECON210 [2014]

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The labour demand curve derives from the MRP curve because firms hire employees unit the wage rate equals MRP *Blue bars represent firm’s MRP of labour *Second graph shows demand for labour curve  same as MRP *One demands the quantity of labour that makes the wage rate  marginal cost of labour, equal to the MRP of labour *Orange line is firm’s MRP of labour curve

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Two related, but different, conditions for profit maximisation: o Profit is maximised when MR=MC  firms producing output that maximises profit o Profit is maximised when MRP = wage rate  firm employing amount of labour that makes MRP equal wage rate Labour demand dependent upon: o Price and quantity of the firm’s output o Prices of other productive resources  relative cost of K to L o Technology Market demand for labour = sum of all quantities demanded by all firms at each wage rate o Increased output of goods = increase in Q of labour demanded at a particular wage o Increased productivity = same quantity of labour but a higher wage being paid The law of demand (movements along the curve) dictates that the Q of labour demanded: o Decreases if the wage rate increases o Increases if the wage rate decreases Changes in demand (shifts in the demand curve) can also take place: o Decreases if: ▪ Firm’s output or price decreases ▪ New technology decreases the marginal product of labour ▪ Cost of labour relative to capital increases o Increases if: ▪ Firm’s output or price increases ▪ New technology increases the marginal product of labour ▪ Cost of labour relative to capital decreases

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Long-run demand for labour o Labour can be substituted for capital in LR o Its importance in production as well as the demand for labour depends on the marginal rate of technical substitution (MRTS) = additional amount of capital required if labour is changed by one unit, holding output constant o For most G&S technology allows some room for choices in the levels of K and L used in the production process o Isoquant curves show the alternative combinations of K and L that can produce a given level of output, with their slope measuring the MRTS Perfect substitutability *10 workers can be substituted for 1 unit of capital for every technical option in production *Relative cost of L to K determines the Q of each factor employed, with an increase leading to lowered demand for labour

Imperfect substitutability *In reality there is imperfect substitution as not all resources are equally as efficient in the production process *Isocost lines show the relative cost of K and L, so that as wages increase relative to capital a movement from Isocost (1) to Isocost (2) ensues and it becomes preferable to choose K *Firms change their production technique from a combination of K1L1 to K2L2

4 ECON210 [2014] *Long-run demand curve becomes more elastic than the short-run demand curve given the substitutability of labour for capital

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Elasticity of demand for labour measures the responsiveness of the quantity of labour demanded, to the wage rate o o Short-run  less elastic due to firm’s inability to adjust  cannot quickly replace labour with capital o Long-run  small wage rises lead to even greater changes in the quanity of labour demanded o Dependent upon: ▪ Labour intensity of the production process  increased labour intensity = increased elasticity of demand for labour ▪ Elasticity of demand for the good  elasticity for the good carries over to labour ▪ Substitutability of capital for labour  where it is easer to substitute other inputs for labour, elasticity of demand for labour will increase

Supply of labour • Determined by the number of people willing to work in a particular field of employment and by the number of hours each person will supply at a particular wage rate  neo-classical approach: o Individual has decided to participate in the labour force o Has no unearned income o Pays no taxes o Wage rate is invariant with the number of hours worked o Free choice in the hours of work • Individuals choose between leisure and goods to provide utility  work is required to gain income required to purchase goods and time not spent as leisure is devoted to work • Analysing an individual’s preferences between work and leisure shows the hours one is prepared to work, plotted on an indifference curve

5 ECON210 [2014] Equilibrium hours of work and goods consumed *Individual gets increased utility or satisfaction when they can get both more leisure AND more goods

o Individuals constrained in their choice due to there being only 168 hours in a week and the wage rate that is offered being outside their control  determines budget constraint, line AB o Value of goods able to be purchased by the individual (G) =  if an individual could work the full 168 hours the value of the goods able to be consumed would = 168W o Where the individual’s indifference curve is tangential to the budget constraint (AB) determines the number of hours an individual will work to maximise their utility o The slope of the indifference curve = slope of the budget constraint o If the worker does not work (Point B) leisure would be 168 hours, and if they worked 168 hours (Point A) they would have zero leisure *Worker has L1 hours of leisure and will work 168 hours  L1 hours *Worker is able to purchase quantity G1 goods which will be equal to the number of hours worked multiplied by the wage rate *Thus there is a trade off between labour and leisure

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Two effects will influence whether or not individuals work additional hours when wages increase: o Substitution effect ▪ Change in the desired hours of work resulting from a change in the wage rate, holding income constant. ▪ When the wage rate increases, the relative price of leisure is altered  the opportunity cost of leisure increases ▪ Additional income and thus purchasing power is gained by working additional hours ▪ Thus the wage increase induces individuals to work additional hours o Income effect

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Change in the desired hours of work resulting from a change in income, holding the wage rate constant Wage rate increases means that a larger money income is obtainable from a given number of hours worked Individuals would use part of this extra income to purchase G&S but the individual may also purchase leisure that takes away from time at work ultimately leading to a reduction in the number of hours worked

The backward-bending supply of labour curve *As wages rise, the income effect eventually becomes larger than the substitution effect *At high income levels workers will desire more leisure and work less hours *Total supply of labour curve is the sum of the individual supply curves *Another consideration is the reservation wage = lowest wage at which one is willing to supply labour, which is where the curve begins on the y-axis

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Changes in the supply of labour affected by: o Adult population  migration and the birth rate o Participation rate  percentage of working-age population in the labour force = ▪ An increase in the participation rate means that a larger % of the working age population are working or seeking employment ▪ Increasing the participation rate increases the size of the labour force which increases the supply of labour and shifts its curve to the right ▪ All other things being equal, a higher participation rate will lower unemployment OR the wage rate ▪ Participation rate has risen due to: • Changing attitudes to women working • Increased availability of part-time work • Increased single-parent families • Increased costs of living Within an individual industry, labour supply affected by:

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o Desired skill level  minimum qualifications; experience; education and training levels o Fringe benefits  Workers themselves may also be influenced by: o Job security o Dangerous nature of the job o Opportunities for promotion o Level of job satisfaction o Working conditions o Job’s status in society •

Labour market equilibrium occurs when the quantity of labour willing to work (at a particular wage level) is equal to the quantity of labour employers wish to employ at that wage level  a free market at equilibrium returns zero unemployment *Labour market at equilibrium

*Increasing demand for labour shifts the demand curve to the right from DL to DL1 *Equilibrium wage rate rises to $18 and the quantity of labour employed increases to 3000 hours per day

8 ECON210 [2014] *Increasing supply of labour will shift the supply curve to the right from SL to SL1 *In a free market, the equilibrium wage rate will fall to $12 and the quantity of labour employed will increase to 2300 hours per day

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Award wages provide minimum wage levels in particular industries and are determined by industrial courts or government rulings Award wage above market equilibrium *An award wage of $17 creates excess supply and 2200 remain unemployed

Award wage below market equilibrium *An award wage of $12 creates a shortage of workers *Employers, especially those in the private sector, would offer overaward payments and pay the market equilibrium wage of $15

The internal labour market • Refers to the labour market within an individual firm • When one is employed by a firm they are employed based on the external labour market = demand and supply for labour within that entire industry o Decisions about wages, employment, job allocation and training are controlled by economic variables

9 ECON210 [2014]

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o Individuals compete against each other for the position based on their abilities and experience Generally after an initial probationary period, workers receive advantages from being in the internal labour market, over comparable workers in the external labour market  one presently occupying any job has rights over those who do not, generally institutionalised by unions or employers Employers and employees form attachments to each other, which render the HR process (dismissal and resignation) difficult Decisions about wages, employment, job allocation and training are governed by administrative rules and procedures Jobs are arranged in a hierarchy, with seniority based on promotion and wages on the position held not on the individual  wage structure often reflects external demand and supply for these positions  internal knowledge will often lead to higher wages as employers strive to keep those workers who know too much o Firms will use job evaluations or appraisals to decide promotion based on a set of criteria and common assessment  wages increase in line with these ▪ Increases may be based on individuals’ performances = merit pay plan  may create unrest if others believe the criteria have not been fairly applied o Ensures equity in the workplace and promotes efficiency Employees progress to the top of the hierarchy by acquiring on job skills and experience. As advancement depends on years of service, labour turnover trends to be low, further reinforced by non-portable sick leave, superannuation schemes and long service leave How are internal labour markets an advantage to an employer? o Reduction in employee turnover  reduces need for costly training o Filling vacancies internally reduces recruitment costs o Clearly defined job ladders incentivise workers to be disciplined, productive and to seek new skills o Increased productivity and commitment to the firm from worker benefits, job security and opportunities for training and promotion o Shielded from competition from the external market which increases their own chances of promotion o Structured rules and regulations results in less unfair treatment and more contended employees

The role of trade unions • Unity of workers to negotiate with their employers as they believe their aims are better achieved through solidarity in numbers  membership depends on whether the perceived gains exceed costs • Goals of trade unions o Increased real wages o Reductions in the standard working week o Improvements in working conditions o Greater security of employment o Increased employment

10 ECON210 [2014]

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Unions have achieved higher wages for workers than non-unionised sectors  7-15% higher in 1980s, though this has slowed to 3-4% due to declining union membership and therefore bargaining power Unionisation rates have declined across all age groups, particularly younger ones and tends to occur in only particular industries, most significantly education and public administration/safety Many such as the Howard Liberal government have argued that workers on AWAs earn more than those on collective agreements, however data such as mean weekly earnings does not consider the number of hours worked Achievements of trade unions o Use of industrial and political pressure (via ALP) to introduce compulsory superannuation o Reduction in the working week from 48 to 35-38 hours o Improvements on leave and leave loadings (sick; long service; annual) o Improvements in maternity, paternity and family leave o Improvements in worker safety and WC o Establishment of awards, redundancy pay, unfair dismissal and equal pay for equal work across genders and ethnicities Unions’ power is limited by: o Ability to restrict non-union workers from offering their labour in the same market  increasing issue due to individual work contracts and the outlawing of compulsory unionism o Higher wages decreasing the quantity demanded of labour Unions can increase its members’ wages by: o Increasing demand for union labour by: ▪ Increasing the demand for union labour by: • Increasing marginal product through increased skill and training • Encouraging import restrictions • Supporting minimum wage laws • Increasing demand for the good produced • Having closed shops  compulsory unionism in the workplace *Labour market at equilibrium

11 ECON210 [2014] *Labour market following an increase in demand by shifting the demand curve right from DL1 to DL2

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Rendering demand for union labour less elastic *Labour market in equilibrium

*Labour market following a decrease in the elasticity of demand for labour

o Restricting the supply of union labour by: ▪ Limiting immigration ▪ Insisting on minimum qualifications ▪ Limiting the number of qualified people in an industry eg. AMA limiting doctors ▪ Placing restrictions on work in an industry, such as the number of hours one can work ▪ Preference for unionists and unionist-only workplaces

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*Decreasing supply shifts the supply curve to the left, from SL1 to SL2 *This increases the wage rate

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Unions’ methods for achieving their goals o Strikes  withdrawal of labour lasting for, on average, two days o Stop-work meetings o Go-slows o Work-to-rule campaigns o Overtime bans

The role of the employer • Workers in well-run firms with good HR policies and concern/cooperation between employee and employer will see smaller numbers in union membership, while poor working conditions will increase workers’ reliance on a union; employers likewise can band together to increase their power through employer associations whose functions include: o Promoting members’ commercial interests o Influencing government policy by acting as pressure groups o Negotiating terms and conditions of employment with workers o Preventing union involvement as this reduces employers’ power over their workplaces • Employers’ power o Via industrial tribunals and enterprise agreements, can instigate nostrike clauses, stand-down clauses and work ban clauses implemented into awards o Use of the Competition and Consumer Act to prevent secondary boycotts o Sack workers o Discourage union membership o Apply to deregister the trade union o Lock outs  workers not allowed back until management’s orders are followed ▪ Australia only OECD country whose law favours this over strikes, which is lawful only through secret ballot approval at the end of the agreement ▪ Rather than workers joining together to strike and debate matters with employers, they can only mark ballot papers in

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their homes, which weakens union power as workers are separated from each other during the process ▪ Under FWA 2009 employers can only lock out employees as a response to industrial action o Demanding permits from unions before they physically enter the workplace, that indicates that they are a ‘fit and proper person’  Fair Work Amendment Bill 2014 will attempt to implement tighter criteria for granting permits to unions to enter workplaces Additional powers granted through WorkChoices o Law stated that duress could not be applied to a worker or employer however the latter could insist on the former signing individual contracts in the case of new employees  empowered individuals by allowing them to ONLY offer individual contracts which removed workers’ rights to bargain collectively as a group or with union representation o Abolished ‘no disadvantage test’ which meant that individual contracts did NOT necessarily have to better the basic rates and leave conditions offered under industrial awards as per the Australian Fair Pay and Conditions Standard o...