Assignment # 1 Roll #: 16103123-005

Marks

Assignment Topic:
Describe Wages and Employment in an Imperfectly Competitive
Labor market.
Subject Name:
Chemical Engineering Economics
Submitted To:
Engr. Zafar Shakoor
Submitted By:
Qasim javed
Roll No:
16103123-005
Semester:
8th
Department:
BSc. Chemical Engineering and Technology

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 Wages and Employment in an Imperfectly Competitive
Labor market.

1. Introduction:-

The role of imperfect labor markets, especially the role of trade unions and
government interventions (such as welfare systems and employment legislation), has been much discussed
in the last decade within the nostrum of supply side economics, the counterpart of rigidities in product
markets has been less of a focus. Product market imperfections can influence employment paths through
time without shifts in the price/marginal cost mark-up, through rent sharing by firms with workers perhaps
at the behest of union negotiated wages. Outside these restricted circumstances wage mark-ups require the
presence of surplus rents and there will therefore be a key interaction between product market power and the
ability to capture rents in shaping wage levek and changes.

There are two sources of imperfect competition in labor markets. These are demand side sources, that is,
labor market power by employers, and supply side sources: labor market power by employees.

A competitive labor market is one where there are many potential employers for a given type of worker, say
a secretary or an accountant. Suppose there is only one employer in a labor market. Because that employer
has no direct competition in hiring, if they offer lower wages than would exist in a competitive market,
employees will have few options. If they want a job, they must accept the offered wage rate. Since the
employer is exploiting its market power, we call the firm a monopsony.. If coal miners want to work, they
must accept what the coal company is paying. This is not the only example of monopsony. Think about
surgical nurses in a town with only one hospital. Employers that have at least some market power over
potential employees is not that unusual. After all, most firms have many employees while there is only one
employer. Thus, even if there is some competition for workers, it may not feel that way to potential
employees unless they do their research and find the opposite.

2. Imperfection in Labor Market:-

In the real world, labour markets are rarely perfectly
competitive. This is because workers or firms usually have the power to set and influence wages and
therefore wages may be set to levels different than anticipated by Marginal Revenue Product (MRP) theory.
Imperfections in the labour market cause wages to differ from a competitive equilibrium.

2.1Different imperfections in labour market:-

 Monopsony.
 Trade unions.
 Discrimination.
 Difficult to measure productivity.
 Firms, not profit maximisers.
 Geographical immobiliities.
 Occupational immobilities.
 Poor information.

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 2.1.1 Monopsony:-
Monopsony occurs when there is just one buyer of labour in a market. This gives
the firm market power in employing workers. The monopsony can set (lower) wages and limit  the quantity
of workers. Monopsonies are the sole demander for labor; they face the market supply curve for labor. In
order to increase employment they must raise the wage they pay not just for new workers, but for all the
existing workers they could have hired at the previous lower wage. As a result, the marginal cost of
additional hiring labor is greater than the wage, and thus for any level of employment (above the first
worker), MCL is above the Market Supply of Labor.

 The marginal cost of employing one more worker will be higher than the average cost because to
employ one extra worker the firm has to increase the wages of all workers.
 To maximize the level of profit the firm employs Q2 of workers where MC = MRP
 Therefore the firm only has to pay a wage of W2. This is less than the competitive wage.
Even if there is more than one employer, firms may still have the ability to set wages and have a degree of
monopsony power. For workers, there are significant costs and difficulties in moving between employers.
This means that if wages are low, it is costly to give up the job and work for a firm with slightly higher
wages.

Trades union:-
Under certain conditions, Trades unions can bargain for wages above the competitive equilibrium. This can
be achieved by restricting the supply of labour (e.g. closed shops) or threatening to go on strike.

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Trades Unions can cause higher wages, however, in competitive markets, this can have the effect of causing
unemployment of Q1 – Q2

However, Trades Unions can be beneficial if:

 They operate in an industry with a Monopsonistic employer

 They help to increased productivity by bringing in new working practices
 Demand for labour is inelastic
 Efficiency wage theories – when higher wages lead to higher productivity.

3. Discrimination:-
Firms may not be rational but pay some workers different wages on the grounds
of age, race, or gender. See: discrimination in labour markets.

4. Difficult to measure productivity:-

The theory of MRP assumes firms can measure the MPP of a worker however in practice
this is difficult because in many jobs, especially in the service sector productivity cannot be measured
precisely
e.g. how do we measure the productivity of nurses and teachers? Therefore wages may be set due to
different reasons other than MRP.

5. Firms may be non-profit maximisers:-

If demand for a product falls, MRP theory suggests wages are
likely to fall. However, firms may be reluctant to cut wages or make people redundant therefore they may
keep paying high wages despite this.

6. Wages will vary due to geographical differences:-

In the north (e.g. Sunderland), wages tend to
be lower because there are less demand, higher unemployment and more elastic supply curve of
labour. In the South, wages tend to be higher for the opposite reason; firms are more profitable and
are willing to pay higher wages.

In theory, workers from the north could move to the

south to take advantage of better employment
opportunities. However, there are likely to be
geographical immobilities e.g. it is difficult for workers
to move. Geographical immobilities can include

 Workers have attachments to their local

community’s friends, children at local schools.
 Difficult to find housing in the south.
 Poor information about jobs elsewhere.

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 7. Occupational Immobilities:-
Even at periods of full employment (strong economic growth)
workers can be unemployed due to occupational immobilities. This involves having inadequate skills for the
labour market. In a fast-changing economy, some workers can be left behind when old industries close down
and their former skills are not transferable to new jobs. For example, manual workers from manufacturing
may struggle in a high tech service sector based economy. This can lead to structural unemployment.

8. Poor information:-
Workers or firms may suffer from poor information. e.g. workers may be
unaware of better-paid jobs elsewhere. Poor information is one factor that enables firms to have monopsony
power.

9. Understanding Imperfect markets:-

All real-world markets are theoretically imperfect, and the study of real markets is
always complicated by various imperfections. They include the following:

 Competition for market share.

 High barriers to entry and exit.
 Different products and services.
 Prices set by price makers rather than by supply and demand.
 Imperfect or incomplete information about products and prices.
 A small number of buyers and sellers.

For example, traders in the financial market do not possess perfect or even identical knowledge about
financial products. The traders and assets in a financial market are not perfectly homogeneous. New
information is not instantaneously transmitted, and there is a limited velocity of reactions. Economists only
use perfect competition models to think through the implications of economic activity.

The term imperfect market is somewhat misleading. Most people will assume an imperfect market is deeply
flawed or undesirable, but this is not always the case. The range of market imperfections is as wide as the
range of all real-world markets—some are much more or much less efficient than others.

10. Implications of imperfect markets:-

Not all market imperfections are harmless or natural.
Situations can arise in which too few sellers control too much of a single market, or when prices fail to
adequately adjust to material changes in market conditions. It is from these instances that the majority of
economic debate originates.

Some economists argue that any deviation from perfect competition models justifies government
intervention to promote increased efficiency in production or distribution. Such interventions may come in
the form of monetary policy, fiscal policy, or market regulation. One common example of such
interventionism is anti-trust law, which is explicitly derived from perfect competition theory.

Other economists argue that government intervention may be necessary to correct imperfect markets, but not
always. This is because governments are also imperfect, and government actors may not possess the right
incentives or information to interfere correctly. Finally, many economists argue government intervention is

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rarely, if ever, justified in markets. The Austrian and Chicago schools notably blame many market
imperfections on erroneous government intervention.

11. Structures of imperfect markets:-

When at least one condition of a perfect market is not met, it can lead to an
imperfect market. Every industry has some form of imperfection. Imperfect competition can be found in the
following structures:

 Monopoly:-
This is a structure in which there is only one (dominant) seller. Products offered by this
entity have no substitutes. These markets have high barriers to entry and a single seller who sets the prices
on goods and services. Prices can change without notice to consumers.

 Oligopoly:-
This structure has many buyers but few sellers. These few players in the market may bar
others from entering. They may set prices together or, in the case of a cartel, only one takes the lead to
determine the price for goods and services while the others follow.

 Monopolistic Competition:-
In monopolistic competition, there are many sellers who offer similar
products that can't be substituted. Businesses compete with one another and are price makers, but their
individual decisions do not affect the other.

 Monopsony and Oligopsony:-

These structures have many sellers, but few buyers. In both cases, the buyer is
the one who manipulates market prices by playing firms against one another.

12. Imperfect versus perfect market:-

No serious economist believes that a perfectly competitive market
could ever arise, and very few consider such a market desirable. Perfect markets are characterized by having
the following:

 An unlimited number of buyers and sellers.

 Identical or substitutable products.
 No barriers to entry or exit.
 Buyers have complete information on products and prices.
 Companies are price takers meaning have no power to set prices.

In reality, no market can ever have an unlimited number of buyers and sellers. Economic goods in every
market are heterogeneous, not homogeneous, as long as more than one producer exists. A diverse range of
goods and tastes are preferred in an imperfect market.

Perfect markets, though impossible to achieve, are useful because they help us think through the logic of
prices and economic incentives. It is a mistake, however, to try extrapolating the rules of perfect competition
into a real-world scenario. Logical problems arise from the start, especially the fact that it is impossible for
any purely competitive industry to conceivably attain a state of equilibrium from any other position. Perfect
competition can thus only be theoretically assumed it can never be dynamically reached.

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 13. Market wage and employment:-
The wage rate is determined by the whole market, and this
sets the wage rate for all firms in the market. They will demand the labour they need, depending on the
marginal revenue product of labour. The firm itself determines the quantity of labour demanded. If the
demand for labour by an individual firms changes the quantity of workers employed. In the diagram, the
shift in demand for labour (to the left) reduces the level of employment for the single firm.

The competitive market wage rate, and the quantity

of labour employed, is determined by the interaction of
demand and supply. The equilibrium wage rate is the rate
that equates demand and supply, as illustrated below.

Equilibrium wage rate:

Labour supply for the whole market is assumed to be positively related to the wage rate, and the market
supply curve slopes upwards.

14. Changes in market wage:-

Market wage may change following a change in an underlying condition of
demand or supply.

 Shifts in demand of labour:-

Demand can change, and the demand curve will shift, under a number of
circumstances, including changes in:

 The productivity of labour.

 The price of the product.
 Demand for the product.

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  Shifts in supply curve:-
Labour supply can change under a number of circumstances, including
changes in:

 The length of the working week.

 Participation rates.
 Demographic factors, such as migration, and changes in
the age structure of the population.
 Qualifications and skills required.
 The length of training.

 Importance of Elasticity:-
The effect on the wage
rate and level of employment of a shift
in either the demand or supply of labour
depends upon the elasticity of the other
curve.

For example, if the demand for labour is

very inelastic, perhaps because there are no
substitutes for labour, the effect of a strike is
to raise the wage rate, but leave employment
largely unaffected. The result is that workers
will gain as a group, even though some
individual workers will lose their jobs.

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15. References:-
 https://www.economicshelp.org/labour-markets/labour-market-imperfections/
 https://www.investopedia.com/terms/i/imperfectmarket.asp#:~:text=Competition%20for%20market
%20share,than%20by%20supply%20and%20demand
 https://www.economicsonline.co.uk/Labour_markets/Wages_and_employment.html#:~:text=The%20wage
%20rate%20is%20determined,all%20firms%20in%20the%20market.&text=If%20the%20demand%20for
%20labour,employment%20for%20the%20single%20firm.
 https://www.oecd.org/social/labour/2502995.pdf
 https://www.clevelandfed.org/newsroom-and-events/publications/economic-commentary/economic-
commentary-archives/2007-economic-commentaries/ec-20070501-the-minimum-wage-and-the-labor-
market.aspx
 https://www.econstor.eu/bitstream/10419/96758/1/dp8034.pdf
 https://opentextbc.ca/principlesofeconomics2eopenstax/chapter/wages-and-employment-in-an-
imperfectly-competitive-labor-market/