Chapter 11

11.1 Characteristics of Monoploy

Single seller – a sole producer
No close substitutes – unique product
Price-maker – control over price
Blocked entry – strong barriers to entry block potential competition
Nonprice competition – mostly PR or advertising the product

A pure monopoly means that there is only one producer of the good with no close substitutes
being produced by any other firms. Since the firm is the industry, they have control over the
price that is charged for their good. Monopolies are created and sustained due to strong entry
barriers which makes it very difficult for new firms to enter the industry. There is very little
non-price competition since there are not any rival firms. There is some non-price competition
which merely meant to increase the demand for the good.

Examples of Monopoly
Public utility companies
- Natural Gas
- Electricity (e.g. OPG)
- Water (e.g. locally Durham Region)
Near monopolies
- Intel (70% market share)
- Wham-O Frisbee (70% market share)
Professional Sports Teams (e.g. locally Raptors)

Monopolies are rare but many examples of near monopolies exist. Examples of monopoly or
near-monopolies today include the gas company, electric company, and the cable TV company.
Private companies such as Intel and Wham-O have significant market share. Even professional
sports teams may enjoy being a monopoly in their respective geographical area. Of course,
there is almost always some competition even for these firms.

11.2 Barriers to Entry

The factors that keep firms from entering an industry:
- Economies of Scale
- Legal Barriers: Patents and Licenses
- Ownership of Essential Resources
- Pricing
Economies of scale constitute one major barrier.
This occurs where the lowest unit costs and, therefore, lowest unit prices for consumers
depend on the existence of a small number of large firms or, in the case of a pure monopoly,
only one firm. Because a very large firm with a large market share is most efficient, new firms
cannot afford to start up in industries with economies of scale.
1. Public utilities are often natural monopolies because they have economies of scale in the
extreme case where one firm is most efficient in satisfying the entire demand.
2. Government usually gives one firm the right to operate a public utility industry in exchange
for government regulation of its power. Legal barriers to entry into a monopolistic industry also
exist in the form of patents and licenses.
1. Patents grant the inventor the exclusive right to produce or license a product for twenty
years; this exclusive right can earn profits for future research, which results in more patents and
monopoly profits. 2. Licenses are another form of entry barrier. Radio and TV stations and taxi
companies are examples of government granting licenses where only one or a few firms are
allowed to offer the service. Ownership or control of essential resources is another barrier to
entry. 1. International Nickel Co. of Canada (now called Inco) used to control about 90 percent
of the world’s nickel reserves and DeBeers of South Africa controls most of the world’s diamond
supply (see Last Word). 2. Professional sports leagues control player contracts and leases on
major city stadiums. Monopolists may use pricing or other strategic barriers such as selective
price-cutting and advertising. Microsoft charged higher prices for its Windows operating system
to computer manufacturers featuring Netscape Navigator instead of Microsoft’s Internet
Explorer. U.S. courts ruled this action illegal.

11.3 Monopoly Demand

The monopolist is the industry
The firm’s demand curve is the market demand curve
Downsloping demand curve
Marginal revenue is less than price

Marginal revenue is less than price

Price will exceed marginal revenue because the monopolist must lower the price to sell the
additional unit.
The lower price is applied to all of the units being produced, not just the last unit, thereby
causing marginal revenue to be less than price.
The added revenue will be the price of the last unit less the sum of the price cuts which must be
taken on all prior units of output.
Marginal Revenue is less than Price
Monopolist is a price-maker
Monopolist sets prices in the elastic region of demand curve (Recall TR↑ as P↓)

11.4 Output & Price Determination

Cost Data
Assume competitive factor markets
MR=MC Rule
No monopoly supply curve
There is no unique relationship between price and quantity supplied for the monopolist.

Misconceptions of Monopoly Pricing

Not the highest price
Total, not unit, profit
Possibility of losses
Monopolists are not protected from changes in demand.

11.5 Economic Effects of monopoly

Price, Output, and Efficiency
Monopoly is inefficient relative to a perfectly competitive industry
Pm > MC (MB > MC) (Allocative inefficiency)
Pm > minimum ATC (Productive inefficiency)

Monopoly and Deadweight Loss

Under Monopoly
CS is less
Redistribution from consumers to monopolist
Sum of CS and PS is less
The net loss is Deadweight Loss of monopoly
MB > MC
Allocative efficiency is not achieved

Income transfer
Consumers to business owners (Income distribution is more unequal than it would be under a
more competitive situation)
Cost complications
Economies of scale (e.g. spreading large initial capital cost over a large number of units of
output)
X-Inefficiency (no competitive pressure to produce at the minimum possible ATC)
Rent-seeking expenditures (e.g. lobbying to acquire or maintain government‑granted
monopoly privileges)
Technological advance (The evidence is mixed)

Income distribution is more unequal than it would be under a more competitive situation. The
effect of the monopoly power is to transfer income from the consumers to the business
owners. This will result in a redistribution of income in favor of higher-income business owners,
unless the buyers of monopoly products are wealthier than the monopoly owners.
Costs complications: Costs for monopolies may not be the same as for more competitive firms.
Following are 4 reasons why costs may differ:
1.Economies of scale may result in one or two firms operating in an industry experiencing lower
ATC than many competitive firms. These economies of scale may be the result of spreading
large initial capital cost over a large number of units of output (natural monopoly) or, more
recently, spreading product development costs over units of output, and a greater
specialization of inputs.
2.X‑inefficiency may occur in monopoly since there is no competitive pressure to produce at
the minimum possible costs. (see next slide for graph)
3.Rent‑seeking behavior often occurs as monopolies seek to acquire or maintain
government‑granted monopoly privileges. Such rent‑seeking may entail substantial costs
(lobbying, legal fees, public relations advertising, etc.), which are inefficient.
4.Technological progress and dynamic efficiency may occur in some monopolistic industries but
not in others. The evidence is mixed. Some monopolies have shown little interest in
technological progress. On the other hand, research can lead to lower unit costs, which help
monopolies as much as any other type of firm. Also, research can help the monopoly maintain
its barriers to entry against new firms.

Assessment and Policy Options

Legitimate concerns
Three policy options:
Charges under Canada’s anti-combines laws
Regulate prices and operations of natural monopolies
Ignore monopolies which are unsustainable over the long term

11.6 Price Discrimination

Charging maximum price customer will pay
Charging customer one price for 1st set purchased and lower price for subsequent units
Charging some customers one price, others another
Conditions
Monopoly Power
Market Segregation
No Resale
Examples
Airlines
Theatres, golf courses
Coupons
International trade

11.7 Regulated Monopoly

● Natural monopolies traditionally have been subject to rate (price) regulation
e.g. natural gas distributors, regional telephone companies, electricity suppliers
● Trend to deregulation where possible
e.g. long distance telephone

● May be desirable to maintain but regulate a natural monopoly

Types of regulation include:
❖ Socially optimal price where P = MC
❖ Fair-return price where P = ATC

Dilemma of Regulation
Setting price at P = MC
❏ Firm earns losses
Setting price at P = ATC
❏ Underallocation of resources
Regulation can improve outcomes

Chapter 12 Monopolistic Competition and Oligopoly

12.1
Relatively large number of sellers
- Small Market Shares
- Limited control over market price
- No Collusion
Independent Action
 - Actions by one firm will not trigger a response
e.g. a price cut by a single firm may result in an increase in its sales.

In monopolistic competition, firms can differentiate their products by the product attributes, by
service, with location, or with brand names and packaging. There is relatively easy entry and
exit, just not as easy as with perfect competition. That is why the number of sellers is not as
large as in perfect competition, but it is relatively large. This type of market experiences some
pricing power due to the differentiated product. If a firm goes to the trouble and expense of
differentiating their product they should let people know about it. They can do this through
advertising

Differentiated products
- Product Attributes
- Service
- Location (local store / supermarket)
- Brand Names and Packaging
- Some Control Over Price

In monopolistic competition, firms can differentiate their products by the product attributes, by
service, with location, or with brand names and packaging. There is relatively easy entry and
exit, just not as easy as with perfect competition. That is why the number of sellers is not as
large as in perfect competition, but it is relatively large. This type of market experiences some
pricing power due to the differentiated product. If a firm goes to the trouble and expense of
differentiating their product they should let people know about it. They can do this through
advertising.

Easy entry and exit

- Firms are small
- Economies of Scale are few
- Capital Requirements are low
Advertising
- Nonprice Competition
- Firm’s demand curve shifts to the right and becomes less elastic.

In monopolistic competition, firms can differentiate their products by the product attributes, by
service, with location, or with brand names and packaging. There is relatively easy entry and
exit, just not as easy as with perfect competition. That is why the number of sellers is not as
large as in perfect competition, but it is relatively large. This type of market experiences some
pricing power due to the differentiated product. If a firm goes to the trouble and expense of
differentiating their product they should let people know about it. They can do this through
advertising.

Monopolistically Competitive Industries

Industry concentration
i. Four-firm concentration ratios
4 Firm CR= ​Output of 4 largest firms
Total output in the industry
ii. Herfindahl index : Sum of squared market shares
HI= (%S1) ^2+ (%S2)^2 + (%S3) ^2

Four-firm concentration ratios are a measure of industry concentration. Four-firm

concentration ratios are low in monopolistically competitive firms as in the table on the next
slide. One of the cautions of using these is that they reflect national output (sales numbers)
and would not be reflective of a localized monopoly.
Herfindahl index – the lower the HI, the more competitive the industry. The Herfindahl Index is
another measure of industry concentration and it is the sum of the squared percentage of
market shares of all firms in the industry. Generally speaking, the lower the Herfindahl, the
lower the industry concentration.

12.2 Price & Output in Monopolistic Competition

- Demand is highly elastic
- The Short Run: profit or loss: Produce where MR=MC
- The Long Run: only a normal profit: Entry and exit
- Inefficient
- Product variety
The firm’s demand curve is highly, but not perfectly, elastic. It is more elastic than the
monopoly’s demand curve because the seller has many rivals producing close substitutes. It is
less elastic than in perfectly competition because the seller’s product is differentiated from its
rivals, so the firm has some control over price.
In the short run situation, the firm will maximize profits or minimize losses by producing where
marginal cost and marginal revenue are equal, as was true in pure competition and monopoly.
The profit maximizing situation is illustrated in the next slide and the loss minimizing situation is
illustrated following that.
Much like in pure competition, in monopolistic competition the profits in the long run are equal
to zero because of free entry and exit into and out of the industry. As we examine the industry,
we will find that it is inefficient.
Firms produce the quantity where MR = MC just like in other industries. It is possible to make a
profit in the short run. (Price – ATC) * Q = Economic profit.
At the profit maximizing output, price is higher than ATC and the firms enjoy an economic profit
in the short run.

Firms will produce the quantity where MR = MC to maximize profits. It is possible to make a
loss in the short run. (Price – ATC) * Q = Economic profit or loss. At the profit maximizing
output, price is below ATC and therefore a loss is incurred.

In the long run firms still produce the quantity where MR = MC. In the long run firms will enter
the industry if economic profits were enjoyed, shifting demand left and profits fall. In the long
run firms will exit the industry if there are economic losses, shifting demand to the right and
losses shrink. This will continue until the price settles where it just equals ATC at the MR=MC
output. At this price, the monopolistically competitive firm earns a normal profit.

12.2
Complications
Persistent positive profits may persist if:
- There is continuing and significant product Differentiation
- Entry is somewhat limited by the financial investment required to establish product
differentiation

12.3
Inefficient
Productive inefficiency
- P > ATC
Allocative inefficiency
- P > MC
Excess capacity
- The gap between min ATC and output*

Productive Efficiency means that the firm is producing in the least costly way and is evidenced
when P = min ATC.
Allocative Efficiency means that the firm is producing the right amount of output and is
evidenced when P = MC.

12.4
The firm constantly manages price, product, and advertising.
- Better product differentiation
 - Better advertising
The consumer benefits by greater array of choices and better products.
- Types and Styles
- Brands and Quality

Monopolistically competitive producers may be able to postpone the long-run outcome of just
normal profits through product development, improvement, and advertising. Compared with
pure competition, this suggests possible advantages for the consumer. Development, or
improved products, can provide the consumer with a diversity of choices.
Product differentiation is at the heart of the trade-off between consumer choice and
productive efficiency. The greater number of choices the consumer has, the greater the excess
capacity problem.

12.5
A few large producers
Homogeneous or differentiated products
- Homogeneous Oligopoly
- Differentiated Oligopoly
Control over price
- Mutual interdependence
- Strategic behavior
Entry barriers

The entry barriers in oligopoly are not as great as in monopoly, thus we have a few producers.
There may be homogeneous or standardized oligopolies like the steel and oil markets. There
may also be differentiated oligopolies like the markets for breakfast cereal, beverages, and
automobiles. Control over price is limited because there is just a few sellers in the market and
rivals may respond in a way that would be detrimental to the firm that just changed the price.
Entry barriers are more substantial than in monopolistic competition which is why there are
just a few producers in the market. Although some firms have become dominant as a result of
internal growth, others have gained dominance through mergers.

12.5
Mergers
- Combining of two or more competing firms
e.g. steel, airlines, banking, entertainment
Motivations:
- Increase in market share and higher economies of scale
- Higher monopoly power
 - Higher product price
- Lower production costs

12.5
Oligopolistic Industries:
Four-firm concentration ratio
- 40% or more to be oligopoly
Shortcomings
- Localized markets
- Interindustry competition
- World trade
- Dominant firms

To be an oligopoly, the 4-firm concentration ratio must be at least 40%.

Localized markets may have just one producer which is a monopoly, while a low 4-firm
concentration ratio indicates a lot of competition in the national industry.
Inter-industry​ competition occurs when industries like glass and plastic compete with each
other.
This competition is not reflected in their high 4-firm concentration ratios.
World Trade​ is not taken into account when calculating concentration ratios.
Dominant Firms​ in the industry exhibit dominance that may be disguised and not reflected in
the 4-firm concentration ratio.

12.6
Oligopolists must make plans in light of the actions and expected reactions of their rivals
Basic concepts:
- Players
- Rules
- Strategies
- Payoffs
- Equilibrium

12.7
Two distinct pricing strategies:
- Collusive pricing
- Price leadership
There is no one simple model to predict outcomes due to:
- Diversity of oligopolies
- Complications of interdependence
Cartels and Other Collusion: Cooperative Strategies
Collusion: any agreement to fix prices, divide up the market, or otherwise restrict competition
- Reduce uncertainty by avoiding a price war
- Increase profits
- Prohibit new entrants
Each firm acts as if it were a monopolist

PRICE AND OUTPUT

- Three identical firms
- Each firm finds it most profitable to charge P0, but only if its rivals do so
- The answer: collude and agree on price P0

Overt Collusion:
Cartels - a group of firms or nations that collude
- Formally agreeing to the price
- Sets output levels for members
OPEC
Covert Collusion:
- secret, illegal or unwritten, informal collusions
- Nestle and Mars 2013

A cartel is defined as a group of firms or nations joining together and formally agreeing as to
the price they will charge and the output levels of each member. It is illegal here; however,
business with the OPEC cartel is conducted every day. In the past, OPEC has been successful in
increasing the price of the oil they sell by restricting supply.

Obstacles to Collusion:
- Demand and cost differences
- Number of firms
- Cheating
- Recession
- Potential entry
- Legal obstacles: competition policy

Demand and cost differences – because cost and demand differences exist between the
members, it will be difficult for all members to charge the same price.
Number of firms – the more firms who are part of the agreement, the harder it is to maintain.
Cheating – there is always a tendency for members to cheat and this erodes the cartel’s power
over time. See the Prisoner’s dilemma.
Recession – overall demand declines during recessions making cheating more attractive.
New entrants – new producers will be drawn to the industry because of the greater prices and
profits which will increase market supply and decrease prices.
Legal obstacles – laws prohibit cartels and price collusion.

Price Leadership Model

Leadership Tactics
- Infrequent Price Changes
- Communications
- Limit Pricing
- Breakdowns in Price Leadership: Price Wars
Breakfast cereal industry
Price Leadership is an economic model where a dominant firm initiates price changes and the
others in the industry follow the leader. The leader communicates price changes through
speeches, press releases, or articles in trade journals. One result is infrequent price changes
since the leader is never certain that the other firms will follow and there is always the threat of
a price war.

12.8
Prevalent to compete with product development and advertising
- Less easily duplicated than a price change
- Financially able to advertise

Advertising is prevalent in oligopolies since there are differentiated goods and advertising is the
best way to communicate product differences. Product improvements and advertising can be
successful because they are less easily duplicated than a price change. Oligopolists are
financially able to advertise due to economic profits earned in the past.

Potential Negative Effects of Advertising:

- Can be manipulative
- Contains misleading claims that confuse consumers
- Consumers pay high prices for a good while forgoing a better, lower priced,
unadvertised version of the product.
When advertising either leads to increased monopoly power, or is self-canceling, economic
inefficiency results.
12.9
Oligopolies are inefficient
- Productively inefficient P > minATC
- Allocatively inefficient P > MC
Qualifications
- Increased foreign competition
- Limit pricing
- Technological advance

Productive Efficiency is achieved by producing in the least costly way and is evidenced by P =
min ATC. Allocative Efficiency is achieved by producing the right amount of output and is
evidenced by P = MC. Foreign competition has increased rivalry in oligopolistic industries. If
the oligopolist leader practices limit pricing, we may get lower prices. Oligopolies may foster
more rapid product development because of the competition in the industry and with the
firm’s profits they have a means to invest in new technologies.
Chapter 14 The Demand For factors of Production

14.1 Factor Pricing and Demand

Reasons to study how factor prices are determined:
● Money-Income Determination
● Resource Allocation
● Cost Minimization
● Policy Issues (how much to tax, min wage)

14.2 Marginal Productivity Theory of Factor Demand

Factor demand is a derived demand
Marginal Revenue Product
- Productivity
- Product Price

Marginal Revenue Product= Change in Total Rev/ Unit Change in Factor Quantity

- Rule for employing factors: MRP = MFC

- Marginal Factor Cost= Change in total (factor) Cost/ Unit change in factor Quantity
- MRP as the factor demand schedule
- Factor demand under imperfect product market competition

14.3 Determinants of Factor Demand

- Changes in Product Demand
Changes in Productivity
- Quantities of Other Factors
- Technological Advance
- Quality of the Variable Factor

● Changes in the Prices of Other Factors

● Substitute Factors of Production
- Substitution Effect
- Output Effect
- Net Effect
● Complementary Factors of Production

The demand of labour will increases when

● The demand for the product produced by that labour increases.
 ● The productivity (MP) of labour increases.
● The price of a substitute input decreases, provided the output effect exceeds the
substitution effect.
● The price of a substitute input increases, provided the substitution effect exceeds the
output effect.
● The price of a complementary input decreases.

14.4 Elasticity Of Factor Demand

Efd = % Change in Factor Quantity/ % change in Factor Price

Determinants of Efd
● Ease of resource substitutability
● Elasticity of product demand
● Ratio of resource cost to total cost

14.5 Optimal Combination Of Factors

● All factor inputs are variable
● Choose the optimal combination
● Minimize cost of producing a given output
● Maximize profit
In the long run, all factor inputs are variable, and so one must consider what combinations of
resources a firm should choose when all its inputs are variable. A firm will produce a specific
output with the least-cost combination of resources in order to maximize profit.

The Least-Cost Rule

- Minimize cost of producing a given output
- Last dollar spent on each resource yields the same marginal product

Marginal Product or Labour (MPL)​ = ​Marginal Product Of capital (MPc)

Price Of labour (PL) Price of Capital (Pc)

The least-cost rule states that a firm will seek to minimize the cost of producing a given output
in order to maximize profits. A producer’s least-cost rule is analogous to the consumer’s
utility-maximizing rule described in Chapter 6. In achieving the cost-minimizing combination of
factors, the producer considers both the marginal product data and the prices (costs) of the
various factors.
Profit Maximizing Rule
● MRP of each factor equals its price
P L= MRP L & Pc = MRPc
MRP L​ = ​MRPc​ = 1
PL Pc

Just minimizing costs is not enough for maximizing profit. There is only one unique level of
output that will maximize profit. Profit maximization occurs where marginal revenue equals
marginal cost. A firm will achieve its profit-maximizing combination of factors when each factor
is employed to the point at which its marginal revenue product equals its factor price.

14.6 Marginal Productivity Theory of Income Distribution

MRP of each factor equals its price
- Paid according to value of service
- Workers
- Other factors owners
- Inequality
- Productive factors unequally distributed
- Market imperfections

Income is distributed according to contribution to society’s output. Income payments based on

marginal revenue product provide a fair and equitable distribution of society’s income. It is not
a perfect system, however, as it can result in a highly unequal distribution. This may be
because production resources were unequally distributed in the first place. Market
imperfections can also result in unequal distributions. In some labor markets, employers are
able to exert their wage-setting power to pay less-than-competitive wages.
Chapter 15 Wage Determination

15.1 Labour, Wages, and Earnings

Wages are the price that employers pay for labour
Wage rate: Price paid per unit of labour services (e.g. an hour of work)
Nominal wage: The amount of money received per hour, per day, etc.
Real wage: The quantity of goods and services obtained with nominal wage
- Depends on nominal wage and prices
- Real wages reveal the purchasing power of nominal wages

Role of Productivity: Labour demand depends on productivity

Canadian labour is highly productive
- Plentiful capital
- Access to abundant natural resources
- Advanced technology
- Labour quality
- Other factors

The demand for labour, like any other factor, depends on its productivity. The greater the
productivity of labour, the greater is the demand for it. And if the supply of labour is relatively
fixed, that means the average level of real wages will be higher. The U.S. and other advanced
economies benefit from highly productive labour. This is due to the plentiful capital available in
these nations, access to abundant natural resources, advanced technology, the quality of the
labour, and other less obvious factors such as a social and political environment that
emphasizes production and productivity.

15.2 A Perfectly Competitive Labour Market

Market demand for labour
- Sum of firms’ demand
- Example: carpenters
Market supply for labour
- Upward sloping
- Competition among industries
Labour market equilibrium
- MRP = MFC rule
15.3 Monopsony Model
Employer has buying power
Characteristics
- Single buyer
- Labour immobile
- Firm “wage maker”
Firm labour supply is upward sloping
MFC higher than wage rate

In a monopsony market, there is only one buyer for labour. The workers who provide the type
of labour needed have few employment options other than working for the monopsony, maybe
because they are geographically immobile or their skills are not transferable to other jobs. This
makes the firm a “wage maker,” meaning that the wage rate it must pay varies directly with the
number of workers available. In this case, the firm’s labour supply curve will be upward sloping
and the MRC will be higher than the wage rate. To maximize profit, the monopsonist will
employ the quantity of labour at which MRC and MRP are equal

Equilibrium Wage and Employment

- Maximize profit by hiring smaller number of workers
Examples of monopsony power: Nurses, Professional Athletes,
Teachers

The monopsonist will maximize profits by employing a smaller

number of workers and paying a lower wage than the competitive market. Society will obtain a
smaller output and workers receive a wage rate that is less than their marginal revenue
product. While monopsonistic labor markets are uncommon in Canada, there are a few
examples. In the medical area, nurses are typically limited in their choice of employers to the
relatively small number of hospitals that may be in their area. Likewise, professional athletes
are limited through player drafts to specific employers only. In some situations, labor market
workers unionize and create their own monopsonistic power.

15.4 Unions and the Labour Market:Three Models

1. Demand-Enhancement Model
- Increasing demand for the goods and services they help produce – Political Lobby
● Construction unions
● Teachers’ unions
- Altering the price of other inputs
● Higher minimum wage
● Reducing the price of complementary inputs
 ● The output effect

2. Exclusive or Craft Union Model

- Effectively reduce supply of labor
● Restrict immigration
● Reduce child labor
● Compulsory retirement
● Shorter workweek
- Exclusive unionism
- Occupational licensing

Some unions attempt to restrict the supply of labor available and thus affect the wage rate
paid. Labor unions have supported legislation that has restricted immigration, reduced child
labor, encouraged compulsory retirements, and created a shorter workweek. Craft unions
especially tend to control the supply of labor by requiring workers to belong to the union in
order to obtain certain jobs. They may force employers to agree to hire only craft union
members. The craft union then maintains restrictive membership policies to control the labor
supply. A similar situation exists in many professional occupations which may push for
legislation requiring occupational licensing as a way to control the supply of labor.

3. Inclusive or Industrial Union Model

- Organize all available workers
● Canadian Auto Workers
● United Steel Workers
Inclusive unionism
● Can deprive firms of their entire labour supply
● In the short run non-union firms will not emerge

Some unions attempt to restrict the supply of labor available and thus affect the wage rate
paid. Labor unions have supported legislation that has restricted immigration, reduced child
labor, encouraged compulsory retirements, and created a shorter workweek. Craft unions
especially tend to control the supply of labor by requiring workers to belong to the union in
order to obtain certain jobs. They may force employers to agree to hire only craft union
members. The craft union then maintains restrictive membership policies to control the labor
supply. A similar situation exists in many professional occupations which may push for
legislation requiring occupational licensing as a way to control the supply of labor.

Wage Increases and Job Loss

Are unions successful?
 - Wages 15% higher on average
Consequences:
- Higher unemployment
- Restricted ability to demand higher wages

There is much debate as to whether or not labor unions have been successful at raising the
wages of their members. Some evidence suggests that union wages are on average 15% higher
than the wages of non-union workers. However, both exclusive and inclusive unionism tends to
reduce employment in unionized firms. This decline in employment has the effect of restricting
the ability of the union to demand higher wages. Workers will balk against wage rate requests
so high that many workers might lose jobs.

15.5 Bilateral Monopoly Model

- Monopsony and inclusive unionism
- Single buyer and seller
- Not uncommon
- Indeterminate outcome
- Desirability
Bilateral monopolies occur when there is a strong industrial union in a monopsonist labor
market. In this case, there is both a single buyer and seller of labor. The effect on the wage
rate is indeterminate since it will depend on which party has the greater bargaining power.

15.6 The Minimum Wage Controversy

Case Against the Minimum Wage
- Creates unemployment
- Poorly targeted to reduce poverty
Case For the Minimum Wage
- Job losses may not occur in monopsonistic labour markets
- May increase labour productivity
Evidence and Conclusions
- Overall effect uncertain

15.7 Wage Differentials

- Differences across occupations
- What explains wage differentials?
- Marginal revenue productivity
- Noncompeting groups
● Ability
● Education and training
 - Compensating differences
Wages differentials are created by many different forces and can arise from either the supply or
the demand side of the labor market. Even across one occupation, wage differentials can
occur. For example, a surgeon just starting out would expect to make much less than one who
has many years of experience. If we focus on the affect of the labor demand on the wage
differential, we can see that the strength of the labor demand varies greatly among occupations
due to differences in how much various occupational groups contribute to the revenue of their
respective employers. The marginal revenue productivity of these types of workers is high. We
can see this illustrated in the demand for professional athletes. On the supply side, workers
differ greatly in their mental and physical characteristics and in their education and training. In
some groups, there may be fewer qualified workers than in other groups, leading to higher
wages rates for those limited workers. Compensating differences are paid to compensate for
nonmonetary differences in various jobs. Undesirable jobs must pay higher wages to recruit
workers who could just as easily qualify for less demanding positions.

- Workers prevented from moving to higher paying jobs

- Market imperfections
● Lack of job information
● Geographic immobility
● Unions and government restraints
● Discrimination
Why don’t workers just move from lower-paying jobs to higher-paying jobs? Several reasons
can be the cause. Frequently there are market imperfections at work. Workers may not be
aware that there are higher-paying jobs for which they qualify. They may not be able to move
to locations where higher-paying jobs exist because they do not want to leave their families or
friends. Unions and other government restraints may also artificially reinforce wage
differentials. And in spite of legislation to the contrary, discrimination in the workforce still
results in lower wages frequently being paid to women and minority groups.

15.8 Pay for Performance

- The Principal-Agent Problem
- Incentive pay plan
- Piece rates
- Commissions or royalties
- Bonuses, stock options, and profit sharing
- Efficiency wages
Pay schemes are typically much more complex than just a fixed hourly rate. Employers may use
worker pay to encourage a desired level of performance from workers. In the principal-agent
problem, the interests of workers and firms are not identical, resulting in situations where
workers seek to increase their utility by working less than agreed upon. To prevent this, many
firms employ incentive pay plans whereby worker compensation is tied to worker output or
performance. This may be accomplished in several ways. Piece rates compensate employees
according to the number of units of output a worker produces. Commission or royalties tie
compensation to the value of sales. Bonuses, stock options and profit-sharing plans tie
compensation to the profitability of the firm, and efficiency wages seek to enhance worker
efficiency or basically encourage workers to work harder.
Pay for performance plans do have their negative side-effects. Piece rates may encourage rapid
production at the expense of product quality. Commissions, bonuses, stock option and
profit-sharing plans can all lead to encouraging unethical behavior among employees in order
to increase their own personal income at the expense of the firm.

Addendum: The Negative Side Effects of Pay for Performance

- Rapid production pace of piece rates may be costly in long run
- Commissions may cause questionable/fraudulent sales practices
- Bonuses may disrupt cooperation
- Profit sharing can result in free-riding
- Stock options may prompt a false appearance of rapidly rising profit
- Downside to the reduced turnover resulting from above-market wages
Exam
Chapters before midterm: 3 questions (12)