Wages and Work

PoemWhy should I let that toad work Squat on my life?Can’t I use my wit as a pitchfork And drive the brute off?

Six days of the week it soils With its sickening poison-Just for paying a few bills?That’s out of proportion..

Phillip Larkin

The standard view of work in economics

• Work is a disutility. That is, it is intrinsically something that is repugnant and that people would like to avoid

• Work involves an opportunity cost: which is leisure. [OC= the next best alternative foregone]

• People substitute work for leisure at different times.

Is work a disutility?

• Q) Is work something that is intrinsically bad?

• In what circumstances is work rewarding and in what circumstances is it a displeasure?

• Both the property rights determining who owns the results of one's labor and the structure of control over the labor process affect how we feel about work.

The backward bending supply of labor

• If labor is really a disutility, we can expect the following shape for the labor supply curve

wage

Hours worked

One possible explanation for the disutility of a lot of work

• If many people see work as an undesirable activity, it is because of how production is organized, who controls it, and how the benefits from it are distributed.

• One needs to look therefore at how a firm is organized.

What is different about a firm?

• Unlike the relationship between firms where resources and labor processes are allocated in a decentralized situation, within a firm: command.

• Command relations are defined as relationships between superiors and subordinates in which the superior exerts power over the subordinate

• Power- ability to get other to do something to your advantage without being faced with equivalent threat

Why a mini-command economy?

• Two possible explanations:• 1) Transactions Cost (it would be

inefficient to try and arrange work within a firm by competition)—Oliver Williamson

• 2)Incomplete Contracts (one cannot guarantee work effort without some sort of consequence)

Inherent conflict between workers and owners

• Which are the inherent conflictual variables?

r (Pzef ) (Pmm) w

k

Another way to see this conflict

• Rearranging this term, we have

• Pz= w/ef+rk/(ef)+(Pm*m)/(ef)

• Price= unit labor cost+unit profit+unit material cost

• Unit labor cost is the amount of money that employees must be paid for each unit of output produced.

• For a given price, employers want the ulc low so that unit profit is high. Employees want it high, which will make unit profit low.

r (Pzef ) (Pmm) w

k

The critical problem at the center of the firm

• The problem of labor extraction:• Process of transforming labor time than an

employer has purchased into work done• Firms seek to minimize unit labor costs• eg. of ULC : if the company pays wages of $10

per hour and each employee, on average, brings in 25 pounds of fish per hour, then unit labor costs can be calculated as follows:

• ulc = $10/25 = $0.40 in labor costs to produce each unit (pound) of the product

What determines e and w?

• The firm can decide f, but the worker decides e. They both together decide w.

• What is the possible range for w?

• e also depends on w.

The labor market operation

• A firm and an employee are interdependent.

• But the firm is more independent since the cost to be unemployed is greater for the employee

• Cost of job loss (CJL) is the loss of income a worker experiences as a result of being laid off.

Cost of job loss (cjl)

• Cjl= (ww-ui)(ud)• Where cjl is cost of job loss,• Ww=previous weekly wage• Ui weekly unemployment insurance• Ud=unemployment duration• E.g: laid off for 16 weeks. Your job paid

$250 a week, UI=50. cjl=(250-50) X 16=3200$

When is cjl high?

• When weekly wages are high, or the next best alternative (need not be unemployment insurance) is low.

• The next best alternative is sometimes called the fallback wage (the wage rate which you can ‘fall back’ on if you get unemployed. Fall back wages are assumed to be lower than or equal to the wage in the work you are.

Can the firm pay the fallback wage?

• If the firm pays only the fallback wage (let us say minimum wage), there is no cost to the worker to quit (especially if jobs are plentiful).

• So worker may not work!• Thus employer faces a difficult question:

how to motivate workers to work

The shape of the effort function

• Which function is more likely, why?

wage, w

Output per hour, ef Line (I)

Line (II)

A numerical example

What is the fallback wage?

The labor extraction curve

The slope is the marginal increase in output per dollar paid

The unit labor cost ray

Where are profits maximized?

Unit labor cost, and the labor extraction model

Notice one important thing

• In order to maximize profits, the firm has to offer a wage which is higher than the fallback wage.

• This is known as efficiency wages.• This means that the firm automatically sets it

higher than the rate at which workers are willing to work.

• This in turn means that there will be unemployment (shortage of work opportunities)

• Alternative theory for unemployment

Effect of increased unemployment insurance