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PROFESSOR: OK, so what we're
going to do today is the last
in what I'd say are the
core set of lectures.
Our core set of lectures,
we started with
talking about the market.
We then moved on and talked
about consumer theory and did
a series of lectures on that.
Now we're doing producer
theory.
This is the last in our series
of lectures on producer theory
and then basically we
move on to topics.
So the remainder of the section
we'll talk about
things like international trade,
uncertainty, equity and
efficiency, asymmetric
information
in insurance markets.
We'll move on to in the last
part of the course showing you
how you can apply what we've
learned in the basics to
answer a bunch of interesting,
real world questions.
So this is the last of our
core basics lectures.
What we're going to do here is
fit in something that's fallen
through the cracks, which is
we've talked about firms and
their decisions about
how much to produce.
And we've talked about
the output side.
But we haven't talked about
the input side at all.
How do firms decide what kind
of the inputs to use and in
what ratio to use et cetera.
We talked a bit about it.
We talked about isoquants and
isocosts and doing that
tradeoff between inputs.
We haven't really talked about
the input markets themselves.
So firms go and they say, look
I've done my isoquants and
isocosts and I want
63 workers.
Well they've then got to go to
a market for labor and hire
those workers and how does
that actually work.
So today what we want to
focus on is the demand
side of input markets.
That is, what's the actual
market analysis by which a
firm having maximized its
profits and deciding how many
workers it wants goes and
actually finds those workers.
So we're going to do is talk
about demand for factors.
In particular today we'll focus
on the demand for labor.
Although the demand for capital,
the analysis will be
very similar.
But today we're going to focus
on the demand for labor.
And what we're going to do is
begin by focusing on the
demand for labor in a
competitive factor market.
So we're going to begin by
talking about competitive
factor markets.
What I mean by that is that a
perfectly competitive factor
market is one where, just as
perfect competition and output
markets means there's lots of
sellers selling the same good,
a perfectly competitive factor
market means there's lots of
sellers, in this case workers,
selling an identical good.
That is their labor.
So the notion is we're in a
market where there's many,
many workers firms could hire,
all of whom are equally
qualified for a job.
So this is not, obviously,
a high-tech market.
This is some low-tech,
construction, other sort of
blue collar market, where
there's lots of workers out
there who could equally well
be qualified for a job.
In fact what we're going to
assume is that there's a
perfectly flat labor
supply curve.
Let's assume a perfectly flat
labor supply curve.
Perfectly elastic labor supply
just to make life easy.
Obviously it's not
true in reality.
Let's assume we're looking at
some market with perfectly
elastic labor supply.
Now how do we think about what
happens in factor markets in
that world?
Well once again let's start
with the short run.
So in the short run
capital's fixed.
So a firm has said, look, I've
done my short run profit
maximization, my isoquants
and isocosts.
I've decided how many workers
I want given a
fixed level of capital.
And that gives me some
demand for labor.
I can derive a demand for labor
curve by essentially
saying, at different wage rates,
given a fixed capital
price, that will shift my
isocost curve, going back to
the producer theory, at
different wage rates that will
shift my isocost curve, that
will cause me to demand
different amounts of labor.
So that traces out a demand
curve for labor.
And we can see that graphically
in figure 18-1.
So you've got a perfectly
elastic labor supply curve and
then you've got a downward
sloping labor demand curve.
And that labor demand curve
comes from the profit
maximization.
The other way to think about
how we get there though is
interesting.
You say, how do we think about
the marginal benefit versus
the marginal cost of hiring
another worker.
We know the marginal cost is
the wage, that's easy.
What's the marginal benefit
of hiring another worker?
Well recall that another unit of
labor raises output by the
marginal product of labor.
Remember the marginal
product of labor.
We talked about this
a while ago.
This is delta q delta l.
So the next worker raises your
output by an amount marginal
product of labor.
That's what you get from
the next worker.
But that's a quantity.
The firm cares about profit
not quantity.
So what it cares about
is revenues.
So the revenues from the next
worker would be the marginal
revenues that are made on that
next unit times the marginal
product of labor.
That's the marginal benefit to
the firm of the next unit of
labor is the marginal product
that that worker produces
times the marginal revenue
the firm raises from
selling that next unit.
So they have to consider two
things, two margins.
How much is it worth them to
sell that next unit and how
much will be produced by that
next unit of worker?
So if we have a perfectly
competitive labor market, the
marginal cost is going
to be the wage.
So we're going to set this
equal to the wage.
So in a perfectly competitive
labor market the marginal cost
of another worker is the wage
and this is the marginal
benefit of another worker.
So this is going to be the
condition the firm's going to
use to decide how many
workers to hire.
We're going to call
this the marginal
revenue product of labor.
So you're going to set the
marginal revenue product of
labor equal to the wage.
That's going to be your profit
maximizing condition--
the marginal revenue product.
The marginal product is
about quantities.
Marginal revenue product
is about dollars.
What's the dollars that the next
unit of labor produces
for you is your marginal
revenue product.
Now if the output market is also
perfectly competitive.
That is, imagine for a minute
now, take one further step.
Not a perfectly competitive
labor supply but also a
perfectly competitive
output market.
So it's not a monopolist. It's
selling in a perfectly
competitive output market.
Then we know what the
marginal revenue is.
We know the marginal revenue
is the price.
So for a perfectly competitive
output market we could rewrite
this as price times marginal
product of
labor equals the wage.
Because we know the marginal
revenue is the price in a
perfectly competitive
output market.
And basically this makes it even
easier to see which is to
say, look, how many workers
do you hire?
You hire until the wage you pay
that worker is equal to
the price you sell your good for
times how many goods that
worker produces.
If one worker produces 100 goods
and each good sells for
100, then you'll only pay
the worker $10,000.
Basically that is going
to determine your
labor demand curve.
And so the labor demand curve
is also labeled the marginal
revenue product of labor
curve, I'm sorry.
Why is this diminishing?
Why is it downward sloping?
Because remember the marginal
product of labor's
diminishing.
The marginal product of
labor's diminishing.
As a result this curve
is downward sloping.
Now here price is fixed,
so it doesn't matter.
Marginal revenue also is
diminishing so that's going to
make it even more downward
sloping than the
more general case.
But in this specific case of
perfectly competitive output
markets where this is just a
constant price you get this
downward sloping marginal
revenue product of labor curve
because the marginal product of
labor is diminishing, as we
talked about.
So that's the analysis of what
we see for a perfectly
competitive factor market.
So the equilibrium is where the
labor supply curve, which
is perfectly elastic, intersects
this marginal
revenue product curve, which
is determined by how
productive the workers are and
how much money they're making
for you with each unit
they produce.
And that gets you the short
run equilibrium.
Questions about that?
Questions about what
we're doing here?
So that just says the underlying
analysis of where
demand for labor comes from or
where the equilibrium level of
labor is going to come.
It's going to come from
intersection of this demand
with the supply,
which is flat.
Now how is this going to
differ in the long run?
Well let me ask the question
this way, forget the math,
forget the graphs, I'm just
going to ask you intuitively.
In the long run, do we think
the long run demand for
workers will be more elastic or
less elastic than the short
run demand, in general.
Will the long run demand curve,
this is short run
demand curve, will the long run
demand curve typically be
more elastic or less elastic
than the short run demand
curve for workers?
Somebody take a guess.
Yeah.
AUDIENCE: More elastic.
PROFESSOR: More elastic.
Why?
It's more elastic.
But intuitively, don't worry
about the graph, I'm just
looking for intuition.
Yeah.
AUDIENCE: Because in
the long run you
can substitute capital.
PROFESSOR: Exactly.
More substitutability equals
more elasticity.
General intuition you want to
remember for this course.
In the long run if I can
substitute towards capital,
then that long run demand curve
for labor will be even
more elastic than the short
run demand curve.
I'm not going to work through
the math or anything.
I just want you to remember that
intuition that when you
have more margins you can use,
that's more substitutability,
that means more elasticity.
So the idea is in the short run,
if the wage increases for
workers all you can do is if
you hire fewer workers you
just produce less, so you're
sort of stuck.
But in the long run if the wage
decreases you just say,
fine, I'll just use
machines instead.
So in the long run you can
substitute away from workers
towards machines.
So in the long run your
demand curve is
going to be more elastic.
Questions about that?
Now this is all relatively
straightforward, just follows
from producer theory.
The sort of stuff you had to
do in the exam last night.
Let's now talk about a little
more interesting case which is
one of my other favorite words
in economics which is the case
of monopsony.
Not monopoly, but monopsony.
We've been talking in lectures
about monopoly which is the
case where one firm
is the only seller
in the output market.
One firm is the only seller
in the output market.
A parallel case in input
markets is the case of
monopsony which is when one firm
is the only demander in
the input market.
So monopoly is when one firm
is the only seller in the
output market.
The parallel in input markets
is monopsony which is where
one firm is the only buyer
in the input market.
And the key thing that's going
to drive monopsony is that
when there are barriers to exit
from a factor market it's
going to create a monopsony.
And any time there are barriers
to exit, any time
workers are stuck and cannot
leave a market, workers are
stuck working one place, that
will give the employer market
power over those workers.
The classic example is
the company town.
In the 1800s when there were
mining operations and they'd
come in and they'd
hire people.
And basically there
was nowhere else
to work in the area.
These were areas which were
dying agricultural areas there
was nowhere else to work.
You'd go work for the
mining company.
That mining company had
tremendous monopsony power
over you because basically there
was nowhere else to work
within a decent area.
There weren't cars yet.
You couldn't just commute
to somewhere else.
A modern example is MIT's
monopsony power over me.
MIT has monopsony
power over me.
Why is that?
Well that's because my life's
pretty comfortable now.
I'm in a house I've lived
in a long time.
My kids are in schools I like.
I've got a lot of friends.
It'd be a real pain in the
ass for me to move.
And as a result MIT has some,
not unlimited, don't tell
them, but they have some
monopsony power over me
because they know that that's
a barrier to my exit.
To my exiting MIT a barrier
is that I'm very
comfortable and satisfied.
And given the nature tenets of
psychology, it is harder to
move someone with a pull
than with the push.
So someone could come and try
to pull me away, but they're
going to have to blow me
away with an offer--
once again, don't
tell MIT this--
they'll have to blow
me away an offer
because I'm pretty satisfied.
And that satisfaction inherently
gives MIT some
monopsony power over me.
Now the question is what
implications does this have.
And the implications are
quite interesting.
And what they are is a
complicated flip of the
monopoly case.
Let's look at figure 18-2.
Here's an example of
a company town.
Now let's imagine a labor market
where you've got some
labor demand curve, the marginal
revenue product of
labor, MRPL, and some
labor supply curve.
And now labor supply
is upward sloping.
This is a not a perfectly
competitive labor market now.
This labor supply is
now upward sloping.
So the demand curve for
labor we're going to
say is 60 minus l.
So in our example the marginal
revenue product of labor is
going to be 60 minus l.
The notion is you have some
downward sloping demand curve
for labor because of diminishing
marginal product.
The wage you're willing to pay
is diminishing in the number
of workers.
To get that first worker
you'll pay a high wage,
because you got to produce
something.
But as you hire more workers
the wage you're
willing to pay falls.
So the demand curve is
downward sloping.
And let's say that our labor
supply curve is that the
amount of labor workers are
willing to supply is
the wage over 2.
I'm just making this up.
These are just made up numbers
just to make the math work.
So this is it just an upward
sloping labor supply curve.
A higher wage calls
forth more labor.
So let's ask what happens
in the competitive case.
Well in the competitive case
you set the supply equal to
the demand.
Well supply is that firms are
going to set the wage equals
60 minus l.
Labor supply is l
equals w over 2.
So we could just have two
equations and two unknowns we
can solve and get that the
amount of labor supplied in
the competitive case
is 20 units.
20 hours, 20 days,
weeks, whatever.
20 units.
That's the competitive
outcome.
And the wage we can read off
the labor supply curve.
If they're going to supply 20
units, they're going to need a
wage of 40.
So once again we can read that
off the labor supply or the
labor demand curve if there's
going to be 20 workers the
wage is going to be 40.
So the wage, labor competitive
and the wage
competitive is 40.
So in a competitive market with
this demand and supply
curve you should know by now you
just set them equal, you
solve, you get an outcome
of 20 workers
working a wage of 40.
Now let's imagine this isn't
the competitive case.
Let's imagine it's the
monopsony case.
Let's imagine this firm
has monopsony power.
Workers can't exit.
And let's further assume that
the firm cannot wage
discriminate.
Just as we talked about
monopolists that couldn't
price discriminate, we're going
to talk about a firm
they can't wage discriminate.
It has to pay one wage to
all of its workers.
And we'll come back once again
with this assumption.
Just as we talked about price
discrimination we'll come back
and talk about wage
discrimination.
But for now assume a non-wage
discriminating monopsonist.
They have to pay one wage
to all their workers.
Well what that means is just as
when a monopolist wanted to
sell more goods it had to
lower the price, if a
monopsonist wants to hire
more workers it has
to raise the wage.
Parallel thing.
Just as the monopolist had to
lower the price to sell more
units because it had to respect
the demand curve, a
monopsonist if it wants to hire
more workers has to raise
the wage because it has to
respect the supply curve--
parallel.
And what this will do is that
will lead them to under hire
workers ct too low a wage.
Just as monopoly led firms to
under produce at too high a
price, monopsony will
lead to under hiring
at too high a wage.
So once again, to think about
this, let's think about the
firm's decision to hire
an extra worker.
What is the firm's total
expenditure on labor?
Its expenditure on labor is the
wage, which is a function
of the amount of labor, times
the amount of labor.
That's the expenditure
on labor.
So its marginal expenditure, if
you take the derivative, is
going to be w plus
dw/dl times l.
That's its marginal
expenditure.
If you want to hire an
additional worker what's the
marginal cost.
Well I want to hire
an additional
worker, what's the cost?
I've got a pay him w and to hire
him I have to raise the
wage, so I have to pay all my
previous workers more as well.
So to hire one more worker I've
got to pay that worker a
wage and in order to entice
him I've got to raise the
wage, which means I've got to
pay a higher wage to all my
previous workers too.
Once again, remember, I
have to pay one wage.
So if I'm going to hire that
worker there is the same
poisoning effect that we
saw with monopolists.
With monopolists the poisoning
effect was if I want to sell
one more unit I'm going to have
to undercut my price on
all previous units.
For a monopsonist, if I want to
hire one more worker I have
to pay all my previous
workers more.
And that's going to mean that
there's a poisoning effective
in reverse.
That's going to cost me
a lot of money to
hire that extra worker.
So we can actually derive now
a marginal expenditure curve
just as we derived a marginal
revenue curve for the
monopolist.
The marginal expenditure
curve.
So we know expenditure
is w of l times l.
And we know from the supply
curve, we can rewrite this as
w equals 2l.
So that says that the
expenditure on
labor is 2l times l.
So plugging in from the supply
curve the expenditure on labor
is 2l times l.
Its wage is a function
of labor times labor.
So 2l times l.
So that means that marginal
expenditure is 4l.
The marginal expenditure
is 4l.
So we can now draw a marginal
expenditure curve that's
steeper than the labor
supply curve.
Once again it's confusing
but it's all parallel.
It's just we're flipping
everything around from
monopolist. Instead of drawing
that marginal revenue curve
that was steeper than the
product demand curve, now
we're drawing a marginal
expenditure curve which is
steeper than the labor
supply curve.
And once again to find the
outcome we'll find the
intersection of that marginal
expenditure curve with
marginal cost.
Well here we'll find the
intersection of marginal
expenditure curve, I'm sorry,
with labor demand.
I'm sorry, so the parallel was
we found the intersection of
marginal revenue with marginal
cost. Now find the
intersection of marginal
expenditure with labor demand.
That intersection is going
to happen at 12 workers.
So the firm is going
to hire 12 workers.
But what ways you're going to
pay-- once again our first
temptation is to look at that
high intersection and say,
well at that intersection
what's the wage.
We didn't put that on the
diagram for a reason.
Maybe we should have
to throw you off.
Remember, to figure out the wage
you've got to respect the
labor supply curve.
Just like you have to respect
the product demand curve to
figure out the price.
So what's the wage when I hire
12 workers they pay 24.
So the monopsonist is going to
hire 12 workers and pay 24.
It's going to hire the number
of workers where marginal
expenditure equals
the labor demand.
That's going to determine
the quantity.
And the wage they're going
to read off the
labor supply curve.
And as a result this firm is
going to under hire at too low
a wage relative to the
perfect competition.
Relative to the competition
they're going to hire fewer
workers at a lower wage.
So if you think about this,
let's come back to
the example of MIT.
MIT, say, would like to expand
the economics department.
But to do so it's got to poach
an economics professor away
from another university.
Well, it poaches another
professor away from another
university.
And let's say that at MIT pays
all its professors the same.
If they're going to poach
a professor from another
university they're going
to have to pay
the rest of us more.
And that's going to cost
them a ton of money.
So they think think we'd rather
have a little bit more
crowded undergrad class, we
don't really see it here
today, but maybe in general,
more crowded undergrad class
and not get that extra professor
to avoid having to
pay a higher wage to all our
existing professors.
So as a result MIT will under
hire professors and they'll
under hire professors
at too low a wage.
And once you can determine how
big monopsony power is, what
determined how big monopoly
power was?
What was the key thing I don't
want to say what it is because
it will give it away, what's the
key thing that determined
the size of monopoly power.
Yeah.
AUDIENCE: Elasticity demand.
PROFESSOR: Elasticity
of demand.
So just like that, the key
factors going to determine the
market power of monopsonist is
going to be the elasticity of
supply of labor.
The elasticity of demand for a
good is what determined the
market power of monopolist
because as goods were more
elasticity demanded, they
had less ability
to jack up the price.
The elasticity of supply of
labor is what's going to
determine the market power
of monopsonists.
Because if I have
more options.
they can't underpay me.
So if I'm very willing to move
to another university.
That is as my labor supply
curve gets flatter, then
there's less market power that
they have. In particular, in a
perfectly competitive labor
market there's no monopsony
power at all.
So monopsony power is a function
of the options facing
their workers.
Questions about that?
Now the key question this all
raises, at least when I first
learned about it and think
about it, is it maybe was
plausible to think that
monopolists can only charge
one price for their good.
That the iPod is what
the iPod costs.
And you couldn't start charging
different amounts for
iPods to different people.
That would get bad
press and stuff.
But it's seems a little bit
stranger to think that
employers have to pay one wage
to all their workers.
As a matter of fact we know that
MIT doesn't pay the same
to all its professors.
There is some wage
discrimination.
In particular, it's a well known
fact that the way to get
a raise as a professor is to
get an offer from another
university.
Because MIT, the pay structure
professors at competitive
departments like economics is
typically they will underpay
you until the university comes
and says you're worth more,
and then they'll ratchet up
to try to match them.
So there is wage discrimination
in practice at
universities as there is
in most workplaces.
There's very few workplaces
where all
workers make the same.
There's wage discrimination.
So does that mean this
model is irrelevant?
And the answer is,
no, it doesn't.
Because there are still major
barriers to perfect wage
discrimination.
There's some wage
discrimination, but there's a
lot of barriers to perfect
wage discrimination.
The most important one is
workplace norms or fairness.
So what MIT should do, here's
the MIT optimal strategy.
The older the professor, the
less they should pay them.
Not because they're
less productive.
Marginal productivity is
constant, it's not, we get
less productive as we get older,
but put that aside.
It's because the older you are,
the less likely you are
to get up and move.
And the less likely, quite
frankly, other universities
are going to want to hire
you and take you away.
Because no one gets
that excited about
hiring a 60 year old.
So what you should do is take
all the 60 over professors and
say we're cutting your wage
in half or by a third.
Because the truth, we've written
our lectures already,
the wage is already well above
our marginal product.
We're all doing pretty
well anyway.
And the truth is people
wouldn't leave.
So why doesn't MIT do that?
MIT doesn't do that because I'm
going to someday be one of
those old guys.
I'm getting there rapidly.
I say, wait a second, if they're
going to do to me when
I'm 60, I'm going to get out of
here while I'm 45 because I
don't want to be in
that situation.
Because that's unfair.
Workplace norms matter.
Employers really do not like
to discriminate within the
workplace because it breeds bad
blood and ultimately can
lower productivity.
And this is something that we
miss in our basic models.
We don't have fairness and
workplace norms in our models.
So wage is just about setting
the wage that maximizes the
profit, which means screwing
the 60 year olds.
But in fact, in reality,
that's not the
way workplaces work.
And that's what the point
of labor economics is.
If you're interested in this we
have an excellent course in
labor economics that follows
up on these issues.
But a key issue is how much
wage discrimination can be
done given workplace norms,
given the notions of fairness
we have. And the answer is it
might be kind of tough.
Because basically MIT doesn't
want to worry about upsetting
all its younger faculty by
mistreating its older faculty.
And part of that could
be solidarity.
Some of those guys are
my friends and I
feel bad for them.
But partly it could be just more
selfish which is, I don't
want to be at a place that's
going to discriminate in that
way against me when
I get older.
And that's just something that's
missed by the basic
14.01 models.
Questions about that?
Yeah.
AUDIENCE: Couldn't you
model the person's
life wage or something?
PROFESSOR: So yeah.
So what you can do is you could
say to people, look,
when we're hiring you we're
going to overpay you relative
to other universities when
you're young and we'll
underpay you when
you're older.
And so on a lifetime basis
you'll be fine.
What would the problem
with that be?
So let's say the say-- yeah.
AUDIENCE: You'd leave.
PROFESSOR: I'd leave as soon as
I reached that point where
I was being paid more elsewhere
that didn't pay this
downward slope.
And, in fact, there's a lot of
interesting labor economics
theory which says the optimal
formal labor contract is
actually the opposite.
It's to overpay when
you're old and
underpay when you're young.
And the notion is
to get people to
want to stick around.
And so in some sense, common
labor theory says exactly the
opposite of what
you suggested.
You want to overpay older
people to get
them to stick around.
And for many years in America
that's often the way labor
markets worked.
We had very generous pensions
and health benefits and high
wages for older workers.
That equilibrium is now breaking
down because in this
more competitive labor market
you can't afford to overpay
those older workers because
then you can't attract the
younger workers in
the first place.
And we're moving towards a
flatter profile by age.
But that's exactly the set of
interesting issues we have to
deal with in labor economics in
setting pay that we don't
really get into here.
Other questions or
comments on that?
Of course there's another every
reason why MIT couldn't
do this, which is it's
against the law.
We have age discrimination laws
in our country which say
you cannot discriminate
against people based
purely on their age.
MIT could say, well look,
I could demonstrate a
productivity difference.
This guy is publishing fewer
articles than he did 20 years
ago et cetera, but they do
have a legal hurdle to
overcome as well as an
administrative hurdle.
It would be a pain in the ass
for MIT to have to figure out
exactly how to shift their wage
schedule to do all this.
And that causes administrative
costs and extra Deans and
extra things and they just don't
want to deal with it.
So there are other barriers as
well which is administrative
costs and legal costs.
But I think probably the main
barrier is just the difficult
issue of workplace norms
and how it affects the
productivity of the workers who
are behind while you get
rid of these older workers or
underpay these older workers
who aren't as productive.
Questions or thoughts on that?
So now with this monopsony model
in mind I want to go
back and revisit a major topic
that we talked about early in
the course.
And a couple times in this
course we talked about as an
example of how governments can
screw up markets we talked
about the minimum wage.
We talked about if you take a
competitive labor market and
impose a minimum wage above the
competitive level, that
could lead to deadweight loss.
Because what will happen is at
that higher wage firms will
want fewer workers.
Workers who would be happy to
work at the competitive wage
will not be able to work.
Trades which would make social
welfare higher won't be made.
And there will be
deadweight loss.
The monopsony model says that
may not be the case.
Because in the monopsony model,
a minimum wage can play
the same role that optimal price
regulation paid with
monopolists.
Remember with monopolists we
said if you regulated a
monopolist and forced them to
charge a competitive price,
that you could actually
force them into
the competitive outcome.
Well if a minimum wage is set
above the prevailing wage but
that's because a monopsony
prevailing wage is too low,
and the minimum wage is set at
the competitive level, then
you could actually increase
employment and improve
outcomes with a minimum wage.
Sort of counter intuitive.
So let's look at it,
pretty confusing.
Let's look at figure 18-3.
Figure 18-3 once again parallels
a figure you saw on
the entire flip side for price
regulation of a monopolist,
this is the parallel which
is wage regulation of a
monopsonist. Let's walk
through this.
It's pretty confusing so let's
walk through this slowly.
Initially you have a monopsonist
who is hiring at
the point where their marginal
expenditure curve, which is
the dashed line and then
the solid line.
So the line me1 is original
marginal expenditure curve.
It's the me1 plus the me2,
it's that segment.
That line which is, once again,
more elastic than the
supply curve.
That intersects the demand curve
at a labor supply l1.
So they hire l1 workers and
they pay a wage w1.
That's the initial monopsony
equilibrium.
The competitive equilibrium is
where supply equals demand.
That would be hiring l2
workers and paying
a higher wage w2.
So the monopsonist is under
hiring relative to the
competitive firm.
Now let's say the government
rolls in and says we're going
to set a minimum wage and we're
going to happen to get
it right and set it at the
competitive wage level, w2.
Well now let's think about
the monopsonist calculus.
The monopsonist new marginal
expenditure curve is the old
one for the solid segment.
So where it says me2, that solid
segment is still the
marginal expenditure curve.
So as they think about hiring
additional workers, they're
working down that curve.
But once they get to l2 workers
they can't lower the
wage anymore.
So that marginal expenditure
curve, they can no longer
lower the wage below w2.
So their new marginal
expenditure curve hops down
and becomes the minimum wage.
So the new marginal expenditure
curve is the two
segments labeled me2.
It's the horizontal segment
from the y-axis to e2.
And then it jumps up to that
upward sloping segment to the
right of l2.
So the new marginal expenditure
curve is basically
at a wage that's above minimum
wage they continue to behave
like a monopsonist. But once you
hit the minimum wage and
they can't lower the wage
anymore, what happens?
The poisoning effect goes away,
just like we talked
about with the monopolist.
Essentially what this has done
has killed the poisoning
effect.
Because it said as you're
thinking about hiring that
next worker to the right of l1,
typically say I want to
hire them because I'm going to
have to raise my wage to
everybody else.
But you're already paying
everybody else a higher wage.
You're already paying everybody
else the minimum wage.
So there's no poisoning
effect.
You're not going to have to pay
them a higher wage to hire
that next worker because you're
already paying them
that higher wage.
So just as optimal price
regulation undoes the
poisoning effect on the demand
side, optimal wage regulation
undoes that poisoning effect
on the supply side and can
lead you to the optimal
outcome.
So minimum wage can actually
increase employment.
Pretty bizarre.
Minimum wage is our whipping boy
for this course about how
it causes dead weight loss and
leads to lower employment.
Here we're saying, actually,
if we start a monopsony
equilibrium, a minimum wage
could increase employment.
Of course, as you should know,
the minimum wage could reduce
employment even in a monopsony
setting if it
gets set too high.
So if the minimum wage
got set very high--
Jessica maybe this is something
we should actually
add for next year-- so if you
can imagine a minimum wage
that's set very high, that could
lead to a level of labor
supply that's actually below
the monopsony level.
So just as with optimal price
regulation, we talked about
how setting a price too high can
make things worse, setting
a minimum wage too high
can make things worse.
So it's ultimately an empirical
question of does the
minimum wage raise employment,
which would require two
conditions, a monopsony market
and a well-set minimum wage.
Or does it lower employment?
Which can happen either with a
competitive labor market or it
could happen with a poorly-set
minimum wage.
This pretty confusing so you'll
probably have to go
home and think more
about this.
But are there questions now
about anything that's not
apparent from the diagram?
So now this is why we have
empirical economics.
We have empirical
economics, well
really we have two reasons.
One, is sometimes we know the
direction of what we're
looking for, we want measure
its magnitude.
Sometimes we don't even know the
direction, not to mention
the magnitude.
Here's a case we don't even
know the direction.
Will increasing the minimum wage
raise or lower employment
and by how much?
Well how do we test this?
Well the traditional way to
look at it to say, OK, the
minimum wage changes over
time, let's look at what
happens to employment when
the minimum wage goes up.
And what people found was an
increase in minimum wage
tended to be associated
with lower employment.
When the minimum wage went
up, employment fell.
So people took that to mean
that there was a situation
where we're either in a
competitive market or we're
screwing up the monopsony market
by setting too high a
minimum wage.
Because we raised the minimum
wage, employment fell.
And what is wrong with
drawing that
conclusion from that evidence?
Or could someone tell me a story
about why that might not
be a convincing piece
of evidence?
Why the fact that when we
raise the minimum wage
employment falls, why that
may not be by itself be
compelling.
What problem you might have with
that piece of evidence.
If you read that in the New York
Times tomorrow, look at
this graph, we raised the wage
and employment falls.
Clearly minimum wage is bad.
What should your first thought
be upon reading that article?
Well what do we care about?
We care about causation
not correlation.
So what could be causing this
to be correlation but not a
causation effect?
Someone want to try?
AUDIENCE: It would depend
on when you
raise the minimum wage.
PROFESSOR: Right, in particular
what story might
cause this effect?
AUDIENCE: If they're in a
depression and they decide to
raise the minimum wage.
PROFESSOR: Right, what if
governments, worried about
workers in bad economies, that's
exactly when they raise
the minimum wage.
What if the government raised
the minimum wage in bad
economy, because that's exactly
when they're worried
about workers suffering.
Then you would see that a
higher minimum wage is
associated with lower
employment.
But it's got nothing to do with
the higher minimum wage.
It's got to do with the fact
that you raised the minimum
wage when unemployment
is falling anyway.
It's causation versus
correlation.
You have to be critical reader
of evidence like this.
The minimum wage is not
handed down by God.
It's determined by legislators
who are subject to political
pressures which may depend
the state of the economy.
If the minimum wage increases
when employment happens to be
falling, then it will look
like the minimum wage has
harmed employment when
it really hasn't.
So what we do about this?
What we do about this is to try
to think about a way we
can find a causal relationship
between the minimum wage and
employment.
And one way to do that is to
try to find cases where a
minimum wage increased and
yet we know there was no
independent change in
economic activity.
And the way economists have
done that is by looking at
state minimum wages.
Turns out a lot of states
actually set minimum wages
higher than the national
minimum wage.
Not really much anymore because
the national minimum
wage has gone up a lot
the last decade.
But about a decade ago the
national minimum wage, or
about 15 years ago, the national
minimum wage was at a
real historical minimum in
real terms. And a lot of
states exceeded that in setting
their minimum wage.
So take two states, for
example New Jersey and
Pennsylvania.
New Jersey raised its minimum
wage, Pennsylvania doesn't.
But any economic shock is going
to hit New Jersey and
Pennsylvania pretty similarly.
They're both right next to each
other on the East coast.
Any recession's going to hit
them pretty similarly.
So what you could do is you
could ask what happens to
employment in New Jersey when
they raise their minimum wage
relative to Pennsylvania,
which suffers the same
economic shocks but doesn't
raise its minimum wage.
We try to achieve the
gold standard.
What's the gold standard?
The gold standard is
a randomized trial.
What we'd like is literally a
trial where we change the
minimum wage randomly
at different places
and different times.
That's ever going to happen.
So we try to approximate in
what we call a natural
experiment or quasi experiment
which say, are there
experimental interventions that
nature gives us, even if
they're not perfectly
randomized trials.
And this is one.
Here's a situation where we have
two states, very similar,
one raises the minimum
wage and one doesn't.
And they're set by
economic shocks.
You can look at that.
Another way people have taken
this approach is say, well
when the minimum wage increases
it's going to have
different effects in
different places.
And why is that?
That's because the minimum wage
is going to be higher
relative to the market wage in
some areas than in others.
So, for example, when they
raised the minimum wage a
dollar nationally, most people
in Massachusetts already make
more than they raised it to.
So it's not going to affect
Massachusetts much.
Whereas in Mississippi
that's a big hit.
So given a national raise we can
compare states that were
hit harder by that raise to
states that were hit less
hard, another way to
try to do this.
A number of studies have done
this and they've come up with
the striking conclusion that the
minimum wage, if anything,
raises employment, at least at
the levels that we've seen
over the last 15,20 years.
Changes in the minimum wage are
actually associated with
modest, but increases
in employment.
And certainly no decreases.
They've been associated with
modest increases in employment
and not decreases.
And this is really, really
striking because this is
something that economists
just never
even really took seriously.
We always taught that minimum
wage was the bad boy of
economics, and this is saying,
no, in fact, if you take it
seriously and look at the
evidence carefully you can
actually see that a minimum
wage can actually increase
employment as this
model shows.
Now, this is still the subject
of some controversy, there's
still a lot of work on it.
But it then raises the
question of, well how
can this really be?
Don't we have a pretty
competitive labor market?
How do we really have a
monopsony labor market?
And the answer is that if you
look at who's getting the
minimum wage it's largely
younger and low-skilled
workers who don't have a lot
of employment options.
So basically McDonald's in a
given area in a city could
have some monopsony power.
Because people don't
have cars.
These low-income urban youths
don't have cars.
They can't go somewhere
else to work.
They don't have skills so they
can even work retail because
they don't have good enough
skills to work retail.
So McDonald's has them.
McDonald's has some monopsony
power over them because
McDonald's is a job
they can get.
Or McDonald's and Burger King
together maybe are the jobs
they can get.
That gives them some
monopsony power.
So given that's where the
minimum wage is going to bite
the most it's maybe not
implausible that the minimum
wage could actually increase
employment which is what we
see in the studies.
Questions about that?
Yeah.
AUDIENCE: [INAUDIBLE] anti-trust
would it be
possible [INAUDIBLE]
PROFESSOR: Yeah exactly.
So let's take my inner
city example.
McDonald's isn't the
only employer.
There's Burger King and Wendy's
and lots of other
low-skilled employers.
The notion is if there's a few
of them that should be enough
to break any monopsony power
unless they collude.
So likewise just as there's not
supposed to be collusion
on the output side, there are
laws against collusion on the
input side in the same way.
But once again, just as those
laws are hard to enforce on
the output side they're
hard to enforce.
Because what you can do is you
can get together in the back
room, or they can just say,
Wendy's and Burger King can
wait and see what McDonald's
does and just
follow in lock step.
So there's lots of ways to
get around those rules.
But yes, just as there's
antitrust laws on the output
side, there are the labor market
laws on the input side
which get in the way
of collusion.
The difference is those
are more on a
sector by sector basis.
So, for example, the
unionization of the workers
affects the collusion ability
of the employers.
So if the workers are unionized
it's more lax in
terms of allowing employers to
collude as well because the
workers are colluding.
If workers aren't unionized
it's less lax.
And there's a complicated body
of labor law about that.
Other questions?
Yeah.
AUDIENCE: So it would be bad for
unions to try and get an
industry-wide standard
wage or--
PROFESSOR: Well that's about
efficiency versus equity.
If a union got an industry-wide
standardized
wage then that's going to
penalize the talented workers
who would want to go work
elsewhere and help the less
talented workers.
And basically a lot of the
complaints employers have
about unions is that they lose
their talented workers because
the union doesn't allow them
to pay those differentials.
Teachers is a great example
that's very controversial
right now which is,
should there be
merit pay for teachers.
A lot of teachers say, no, there
shouldn't be merit pay
because that's going to violate
workplace norms and
it's unfair.
But we might not be getting the
most talented people into
teaching as a result.
So we'll come back next time
and we'll start our topics
part of the course by talking
about international trade and
whether it's good or bad.
Answer, it's good.
But we'll talk about why.
