EC 320: LABOUR ECONOMICS LECTURE NOTES SEMESTER TWO 2022/2023

 Compensation wage differentials

-Compensating workers for the non -wage characteristics of jobs.
-Adam smith; “It is not the wage that must equated across jobs in competitive market.”
-Firms with unpleasant working conditions must some offsetting advantage (e.g. higher
wage) to attract workers and those with pleasant working environment can get away with
lower wages.
Real sense /world
-Workers and forms are anonymous and it doesn’t, matter who works were.
-They move to whichever market that allows best opportunities equating: wages =marginal
product across market in process.
 Compensating wage differential
 Breaks this anonymity
 Workers differ in their preferences for job characteristics
 Firms differ in their working conditions
 It tells how firms and workers “match & mate” is labour market.

MARKET FOR RISKY JOBS

Assuming
1. –two types of jobs
a) complete safe environment; probability of injury=0
b) Inherently risk environment p(injury=1).
2. Complete information about risk level with every job.

Workers utility function

Utility=f (wage, risk of injury on the job)

 MU of income
- gives ∆U from $1 increase in worker’s income, holding constant risk of injury.
-workers prefer higher w, hence MU of income is positive.
 MU of risk
-gives ∆U of one unit ∆ in probability of holding w.
Assumptions
Risk is bad; so, MU of risk injury is
Note; We shall ignore “risk lovers” i.e. workers who enjoy being exposed to risk of injury.
Supply curve of risky jobs
-Indifference curve Uo ÷ gives information about how much a particular worker dislikes
risky job.
-A worker > working in risky job only if it pays W
-Her utility in safer job Uo will exceed one in risky job U1
-Similarly, she> working in risk job if it pays W1,
-Her utility would rise to U1.
-Indifferent; a worker is in different if risk job pays w1

 Workers reservation price: ∆ŵ-wo

 Definition; reservation price; amount of money that would bribe a worker to accept
the risky job.
 Reservation price could be small or large amount depending on the attitude of
workers forward risks.
 Those who dislikes risk- would demand higher bribe/price to switch from safe to risk
job.ie ∆ŵ increase.

DEMAND CURVE FOR RISK JOBS.

 Firms also must decide whether to provide a risky or a safe work environment to iys
workers.
 This decision will depend on what is more preferable
Determining market compensation differential

-Supply curve slopes upward because the gap between safe and risky job increase, as more
and more workers are willing to work in risky job.
-Demand curve slope downward because fewer frames will offer risky working conditions if
risky firms will have to offer higher wage to attract workers.

-Equates supply and demand gives the bribe /price to require to attract the last worker hired
by firm.

 How firm decides whether to offer a safe or risky environment

-Suppose the hires E* workers regardless the environment.
-If it chooses to offer a safe work environment, the production function;
q 0=α 0 E∗¿
-Parameter; αo-measures change in output when a safe firm hire one more worker.
∝ 0=MPLin safe environment; If p=price of q0
So, p ∝0=value of MPL∈a safe environment .
-If a firm offers a risk environment, its production function is;
q 1=∝1 E∗¿
∝1=MPL∈risky environment ; and value of MPL is p ∝1.
 How does marginal product of labour differ between safe and risky environment?
(∝1>∝ 0)
-Marginal product of labour is higher in risky environment than in safe working
environment.
Why?
-Creating a safer environment firm have to allocate labour and capital to create this
safer environment hence these diverted resources could have been used to produce
output(q).
-If MPL was in deed hire in safe environment, we would never observe anyone
working in risky environment.

Profit levels in both environments.

1. π 0= pα 0 E∗−ω 0 E∗−Profit level ∈safe environment .
π 1= pα 1 E∗−ω 1 E∗− profit level ∈a risky environment .
π 0-firm profit if it chooses to be a safe form.
π 1 -firm profit if it chooses to be risky firm.
-Profit equals to difference between firm revenue (ie p ×∝iE∗¿ price times output produced
and firm cost (wages the firm pays times of workers;ωiE∗¿).
-Costs and revenue are affected by the choice of the firm to be a safer or risky firm.
-Risky firm; higher revenues (produces more output and incurs higher costs. (because of
paying higher wages to attract workers).
-A profit max firm offers a risky environment if π 1> π 0
-θ=pα 1− pα 0: a dollar gain per worker when the firm switches from a safe environment to a
risky one.

Firms decision rule

-Offer a safe environment if ω 1−ω 0>θ
-Offer a risk environment if ω 1−ω 0<θ
Note; -If additional labour cost exceeds the per worker productivity gain (ω 1−ω 0>θ
Firm better off offering a safe environment.
-If additional labour cost is less the per worker productivity gain (ω 1−ω 0<θ firm is better
off or profit max if it offers a risky environment.
Market labour demand for risky worker
-Derived by adding up the labour demand curve of risky firms.
-If compensating wage differential is very high no firm would choose to become risky and
demand for risky worker is zero.
-As CWD falls; There comes a point where a firm would gain from beginning risky, decides
to incur additional labour cost this firm will have a threshold value of θ is equal toθ .
-As CWD keeps falling: risk firm profitable to offer a risky environment and the quantity
labour demand by risky firm rises.
 Its profitable to offer risky environment
 Quantity of labour demand rises by risky firms
 The labour demand curve for risky jobs is downward sloping.
EQUILIBRIUM
-The market ( ω 1−ω 0)* CWD and the number of workers(E*) employed in risky job
determined by intersection of the market demand and supply curves.
-If wages differential exceeds this equilibrium; number of workers willing to work in risky
jobs rises than their demand; hence CWD rises.
-Similarly, as CWD lowers; workers willing to work decreases than their demand hence
CWD rises.
Properties of CWD
i. It is positive; i.e. risky jobs pay more than safe jobs.
ii. Equilibrium CWD (ω 1−ω 0 ¿∗¿is the wage differential required tgo attract
the marginal worker (last worker hired) into risky job.
 Can compensating wage differential go the wrong way?
 What happens when some workers prefer to work in risky job?
 Required: Explain and present the market equilibrium when some workers prefer
work in risky jobs?
HEDONIC WAGE FUNCTION
-Suppose now there are many types of firms
-The probability of injury, P, ca takes any value between 0 and 1.
Indifference curve of different workers.
-Assumption: By convince we assume all workers dislike.
-Different workers dislike risks differently.

-Different workers have different preferences for risk

-Workers A is very risk averse, worker C mind risk.
-The slope of Ic tells us how much the w would have to increase, if a worker hast voluntarily
switch to a more slightly riskier job.
-Slope of Ic is the reservation price a worker attaches to moving to slightly riskier job.
-Worker A; has steepest Ic hence highest reservation price (risk averse).
-Worker C: flattest Ic i.e. lowest reservation price he/she does not mind risk. (through does
not like risk).

Isoprofit curves.
-A profit maximization firm compete for these workers by offering different job packages.
-Packages include wages and particular type of work environment (measured by the
probability of injury).
-Isoprofit curve: accrue showing all points which yields same level of profit. These points are
combinations of wages and risk.

Properties of Isoprofit curves.

1) Isoprofits are upward sloping: Because it costs money to produce safety.
 -Suppose a firm offers a package (wage-risks) at a point P on Isoprofit curve
yielding π 0 profit.
-To become safer from along the same isoprofit when it reduces wages.

2) Wages –risk combinative on higher isoprofit yields lower profits.

-NB points on isoprofit π 0are less profitable than those on π 1
-For any probability of injury (say p*), a wage cut moves a firm to lower
isoprofit
-Decreases wages to rise profits.
3) Isoprofit curves are concave:
Why?
-low of diminishing return applies to production of safety.
-At P and π 0 firm offer a very risky environment
-If a firm reduces risk by offering safety at a cheap cost and move to point Q,
by paying lower wage to keep profit constant.
-If a firm wish to make the environment safer to point R, the firm will have to
incur substantial expenditure. Hence wages would be greatly reduced.
P→Q– Slightly flat curve.
Q→R-quite a steep curve.

Hedonic wage function

  Firm have different isoprofit curves workers have different in
difference curves.
 Labour market marries workers into dislike risk such as worker(A)
with safer form (X) and workers who do not mind risk (worker C) with
risky form like form Z.
-The observed relationship between wages and job characteristics is called a hedonic wage
function.
Equilibrium
-Workers max utility by choosing wage -risk offer that places them on highest Ic.
There is non-random sorting of workers and forms.
-Safe form are matches with safety -loving workers and risky ones are matches with less risk
average workers.
-Workers self-select themselves across a spectrum of firms.
NB;
 Traditional equilibrium; Firms and workers are indistinguishable and there is a
random sorting of workers and forms.
 Compensation wage differential model marries workers and firm that have similar
interests.
UNION, COLLECTIVE BARGAINING AND LABOUR MARKETS
Chapter 13: Modern Labour Economics, Robert S Smith.
Diverse opinions over labour unions:
i. Some people view labour unions as forms of monopolies; i.e. while benefiting their
own members, impose substantial costs on other members of society.
ii. Other view unions as a means by which working person has improved their economic
status and as important forces behind much social legist ration.
In this type discussion will be on;
 Analysing the goals, major activities and overall effects of unions in the context of
economic theory.
Fundamentals questions;
i. What are economic forces on the demand side of the market that constrains unions in
their desire to improve welfare of their members?
ii. How labour unions affects wages, employment, labour productivity, and profits.

UNION STRUCTURE AND MEMBERSHIP

 Labour unions; Organization of workers whose primary objective are to improve the
pecuniary and non-pecuniary conditions of employment among their members.
 Classification; There are two types
i. Industrial union; represents most or all of the workers in an industry or firm
regardless of their occupation.
ii. Craft union; represent workers in a single occupational group.
Examples in Tanzania;
 Unions bargains with employees over various of employment contract;
-Pay and employee benefits
-conditions of work
-policies regarding hiring
-overtime
-job assignment
-promotion
-lay off
-means of dissolving conflicts between employers and employees.
 Bargaining can be lightly centralized; Represents of entire industries sit at bargaining
table to decide on contacts binding multiple employers.
 Decentralized; bargaining takes between union and single employer/company/workers
and management within a company.
 In some countries like Britain unions have their union political party; hence use
political process to gain their benefit. In others U.S unions are not afflicted with any
party; rather unions act as lobbyist for several bills or policies of the government.
 LEGAL STRUCTURE OF UNION IN THE U.S /TANZANIA.
 Constrains on the achievement of union objectives.
 Employees must make agreement that permits them to operate successfully both with
their workers and within their product markets.
 More compensations for workers call for an incentive to substitutes K or L; which use
their cost of production.
 Unions must accept the downward -sloping demand curve for labour.
 Suppose we ignore employee benefits and working conditions;

-Demand curve D⁰e and Di⁰ intersect at initial wage and employment (i.e. w0 &E0).
-Suppose unions seeks to rise wages to w1to employment falls to Eⁱe-if relatively
elastic demand (D⁰e) falls Eⁱi if union faces relatively inelastic demand Dⁱi.
-Ceteris paribus, the more elastic the demand curve for labour is the greater the
reduction in employment due to wage rises.
-Suppose further; The union is on bargaining negotiations process) and the demand
curve has shifted from D⁰e→Dⁱi.
-Success of negotiation by the union to raise wage to w1 will not cause to fall E rather
it will have slowed the growth rate of employment to E2i instead of E3I.
-Unions are powerful in rapid (rapid demand curve shifting out faster growing)
industries with inelastic labour demand.
-Conversely unions are weak in industries with elastic labour demand and in which
curve is shifting in.

HOW DO UNIONS AND EMPLOYEES BEHAVE IN THEIR AGREEMENTS?

The monopoly union model
-A model where the union sets the price of labour and employers by adjusting
employment to max profit.
-The values both w and employment of union members
-The union can aggregate it members preferences hence have union utility function which
depend on U=u (W, E)
-Utility shows above represent utility level over which the union is indifferent.
Monopoly union monopoly
Simplest model of the union employer relationship
-Union sets prices of labor and employer respond by adjusting employment to max profit,
give the new wage rate

 Union max U s.t the constraints of the labour demand curve.

 Labour demand as function of wage rate (abstract from other compensation).
-Union values wages and employment of members.
-Members preferences are aggregate to the utility function depending on the wage and
employment.
-Utility function presented by Ic; downward sloping because the union to use one variable it
has to accept a decline in another variable.
-Convex exhibit diminishing MRS.
Efficient contract model
-The monopoly union model is not efficient
-Both parties could be better off if they agree to jointly determine wages and employment.
-There exists a set of wage and employment combination that one part would prefer and
would leave the other part no worse off.
-The points are efficient contracts (discuss pareto efficiency)