A Video on The Minimum Wage

Building up a strong argument is essential for getting good grades. When evaluating the minimum wage, its not good enough just to write that it creates unemployment. What are the other effects?

Here is a video describing the effects of a minimum wage. Sure it is slightly biased (free marketeers), but that's why their argument against it is really good.

Notes on the labour market, trade unions and the minimum wage can be found here!

Unemployment Notes

Full employment is, according to the Beveridge definition, when 3% or less of the work force is unemployed. At current, the unemployment rate is 8.4% of the labour force, indicating that the UK is performing far from full employment and full productive capacity. More detail can be found from notes published on 5th August.

The Natural Rate of Unemployment (NRU) is the rate of unemployment that occurs even when the aggregate labour market is in equilibrium (AD_L = AS_L). Below is a diagram illustrating NRU.

Point X is the equilibrium, AD_L = AS_L, the market going wage rate is W_FE and full employment occurs when E_FE workers are hired. AS_LN shows how many more workers are willing and able to work at different wage rates but cannot due to frictional (geographical immobility) and structural unemployment (lack of skills). The NRU can be calculated by E_FE – E₁.

NRU can also be linked with inflation. NRU is also known as the Non- Accelerating Inflation Rate of Unemployment (NAIRU). This means that it is the only rate of unemployment that does not alter the rate of inflation.

Causes of unemployment

·     Frictional unemployment relates to the time taken to find a new job, the period between switching from one job to another. Frictional unemployment is caused by:

Ø  Occupational immobility of labour: Workers need more time to switch between jobs because they don’t have new skills to offer new employers. Lack of training courses, for example, makes the search period longer. Along with that, the longer the search period, the less employable the worker gets because they are losing their employability skills (work ethics, behaviour…).

Ø  Furthermore, new employment practices such as laws on equality (race, gender, sexual orientation...) can prevent perfectly capable workers from finding a job. This is one case against government intervention in the economy.

Ø  Geographical immobility of labour: The difficulty of moving to another location to find a new job. For example, the North South divide in the UK means house prices are too high in the South where more jobs may be available. Other reasons that cause difficulties are family ties and attitudes towards moving to new and unknown locations.

Ø  Search theory of unemployment: Those who are unemployed will continue to look for the ‘right’ job, comparing their old job with the other jobs available, for example, pay, travelling distance….etc. Because of this, workers may reject job offers, leading to a longer period of unemployment.

·   Structural unemployment means that workers lose their jobs due to changes in the structure of the economy. For example, the UK’s economy moved from an industrial one in the early 1900s to one based on providing financial services now. This led to the loss of jobs in the manufacturing sector (read this article: http://www.guardian.co.uk/business/2011/nov/16/why-britain-doesnt-make-things-manufacturing?newsfeed=true).

·   Seasonal unemployment occurs because of changes in the weather. When the UK’s climate changes, it affects the agricultural and tourism industries, leading to job losses in the winter.

·   Cyclical unemployment is caused by deficient aggregate demand. Also known as Keynesian unemployment or demand deficient unemployment, the diagram below displays a fall in  AD_L after a fall in AD. This causes employment to drop from E_FE to E₂. See a more detailed explanation as posted on 3rd October.

·   Real wage/classical unemployment is caused by wage stickiness. Collective bargaining by trade unions (see here) causes wages to remain high, causing unemployment.

Ø  The diagram shows that point X is the equilibrium point. The real wage rate is W_FE and employment is E_FE. When trade unions cause the real wage rate to rise, wages become W₁. This causes an excess supply of labour because at W₁, E₁ workers are willing and able to work at this wage rate. However, demand for labour is only E₂, more workers are willing to work than firms wish to hire, thus creating unemployment equal to E₁ – E₂. W₁ is known as the disequilibrium wage rate.

Ø  Free market economists believe that labour market competitiveness would drive down wage levels in time, however trade unions cause wage rigidity preventing it from going back to equilibrium.

It is important to note that unemployment is a waste of human capital. The disadvantages of unemployment are shown in the table below.

One positive of unemployment that classical economists believe is that it brings a downward pressure on inflation. But that’s up to you to decide whether you agree and be sure to write your opinion in the exam. See tomorrow’s post on government policies aimed at reducing unemployment.

Top 10 Posts This Year

Today is a very special day, not just because it is New Year's Eve eve, but because it is the blog's five month anniversary with my first post being on purchasing power parity! Below I have compiled a list of the top 10 posts so far. If these are popular, I am assuming they have been most helpful to you guys, so please have a look at all 10, and good luck with your revision.

10. Trade Unions posted on 16th November

9. Oligopoly Case Study  posted on 16th October. Although it was a few months ago, the case study can still be used as an example.

8. Word of the Day: Economic Growth on a PPF posted on 3rd August

7. Notes on Supply Side Economics and Crowding Out posted on 16th October

6. Word of the Day: Backward Bending Supply Curve  posted on 25th August

5. Negative Externalities posted on 16th September

4. Monopoly posted on 23rd August

3. Word of the Day: Elasticity posted on 13th August

2. Perfect Competition Long Run Equilibrium posted on 11th August

1. Perfect Competition Short Run Equilibrium posted on 10th August

It seems perfect competition is the most popular, not surprising because even I had difficulties with this one.

Keep looking out for more revision notes to come soon!

Trade Unions

A collective association of workers whose aim is to improve the pay and conditions of member workers.

Aim to:

·     Improve real incomes

·     Working conditions

·     Pensions

·     Security

·     Unfair dismissal

·     Counter monopsony power

·     Protect against discrimination

Trade union membership has declined to less than 30% of all those employed in the UK (2007). Reasons for this include:

·     Membership is considered to be a waste since the economy was in a boom creating less of a need to bargain for higher wages

·     Tougher employment laws

·     Little evidence for significant mark-ups in wage levels bought about by trade unions

·     You become less employable if you belong to a trade union

·     Changes to the labour market: decline in jobs in heavy industry to more service sector based, shifts towards shorter employment contracts and more people working part-time/flexible hours

·     Some employers restricted trade unions in their work place

Unions influence pay by:

Ø     Collective bargaining

o      negotiate pay levels above the current levels that exist. This is only effective if the union has control over the total labour supply available in the industry.

Ø     Closed shop agreement – employer and union agree that all workers be part of the union

o      Pre-entry: workers must join the union before starting employment

o      Post-entry: non trade union members get the job but have to join to keep the job. This prevents free-riders benefiting from the mark up bought by the union on wages

o      This was considered to be a labour restrictive practice and is now illegal in the UK

Pre-entry closed shop

The diagram below briefly displays a pre-entry closed shop agreement made by unions.

S1 shows the supply for labour in the market before the closed shop agreement. Supply shifts to the left and becomes more inelastic because the increase in wages has minimal effect on employment if the workers have already been employed by the firm. Employment still, however, falls from L1 to L2 when wages rise from W1 to W2.

Perfectly competitive market

To refresh your memory of the PC market, click on the revision notes of the PC market in the short run and long run.

This diagram shows the effects of a trade union in a perfectly competitive market. The equilibrium wage rate is W1 where the number of workers employed is L1. The effect of the trade union is that wages are pushed up to W2 à the acceptable wage rate for union members. The supply curve becomes W2XS. From W2X, the supply curve is perfectly elastic. Along XS, the curve is upwards sloping because more workers are attracted to higher wage rates. The employer wishes to hire L3 workers but the number of workers willing to work at the wage rate of W2 is L2. Thus there is excess supply of labour, causing classical unemployment between L2- L3. 

This diagram argues that the trade union causes unemployment, however one can counter-argue, as in the Keynesian view. It is unrealistic to assume that demand conditions remain unchanged because higher wages would normally increase demand for output, thus increasing output and increasing demand for workers to produce more output.

This diagram can also be used to explain the effect of the National Minimum Wage, as well as trade union mark-ups.

Look out for more on the effects of trade unions in a monopsonistic market soon! (To prepare yourself, you could read Word of the Day)

Word of the Day

Trade Union

A collective association of workers whose aim is to improve the pay of workers and improve the conditions of work for its members. Some of the things they work to improve include:

• Real incomes
• Pensions
• Security
• Unfair dismissal
• Counter monopsony power that firms hold over workers (see Word of the Day)
• Protect against discrimination

Unions influence pay by:

• Collective bargaining: negotiate pay levels above the current levels that exist. This is only effective if the union has control over the entire labour supply available in the industry.

• Closed shop agreements: Employers and unions agree that all workers be part of the union. This is now illegal in the UK because it encourages labour restrictive practices. Two types, pre-entry and post-entry. Pre-entry is when workers must join the union before starting employment. Post-entry is when workers not part of a union start employment, but have to join a trade union to keep the job.
• This is to prevent free-riders benefiting from the mark-up wages bought about by trade unions.