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Review Question

Restrictions in The Labor Market

Important cases of restrictions that are designed to increase price occur in the resource market. Unionization is one way that sellers in the resource market can restrict sales to raise price. A union can negotiate a contract above the wage the market would set. This possibility is shown below where Pn is the negotiated wage and Pm is the market wage. The firm agrees to this because the alternative is a strike. If the firm could simply replace striking workers with nonstriking workers (called scabs by unionized workers), the threat of a strike would have much less effect. But attempting to do this is likely to cause violence and destruction. The surplus indicated on the graph should show up as a large number of applicants whenever the firm hires. Rationing can take place on a first-come, first-served basis, on the basis of "who you know," or on any other basis the firm and union decide.

Raising wages by rationing jobs

An alternative way to restrict transactions is to restrict supply, an option that usually requires the cooperation of the state. One way it can be done is with licensing. If one cannot enter a profession without a license, and if the number of licenses can be restricted, then fewer people will enter the occupation. This method is shown in the graph below where Supply 1 is the supply curve without licensing and Supply 2 is the supply curve with it. Among occupations that use this method (the list varies from state to state) are teachers, most medical professions, lawyers, accountants, beauticians, barbers, morticians, and veterinarians.

Raising wages by reducing supply

For the use of resources to be efficient, their prices must reflect the value that they could contribute elsewhere in the economy. The price that a person using a resource sees should be the opportunity cost of that resource. The problem that licensing and union power cause is that they generate prices that misstate the opportunity costs of resources. When the cost of a resource that a decision maker uses differs from its social cost (which is its opportunity cost), decisions will be distorted and not economically efficient. For example, if a union contract says that an employer must pay Ian Segoe $10.00 per hour if he works for it, and Ian will only add value of $9.00, the firm will not hire him. Instead he must take a job that pays only $8.00 per hour. Because Ian's labor is not used where it adds the most value, the economy is economically inefficient.

One might object to treating unions and professional licensing in the same way that monopolies are treated. Many people believe that labor unions aid working people and licensing protects the public. They believe that the extra wages that unions obtain for their members come from the profits of big business, and without licensing, the public would be exposed to charlatans. There is often some truth in these beliefs, but not the whole truth.

Effective unions do raise the wages of their members. All economists who have studied the data seem to agree on this point, though they differ on how much unions raise wages of their members relative to those not in unions, with estimates ranging from 5% to 30%. These studies also suggest that the increase in wages for union members has the effect of pushing down wages in nonunionized sectors. The number of workers employed in an industry with successful unions will decrease. Thus, there will be more workers available in nonunionized sectors, causing supply curves to shift to the right. The equilibrium wage rate in the nonunionized sector will be lower as a result of unions.1

Licensing may improve the quality of services, but at the expense of reducing quantity. Hence, even if licensing achieves its stated purpose of improving quality, it is not necessarily true that the consumer is better off. The loss of cheap, low-quality service may offset the higher quality; would automobile drivers be better off if they could only buy Rolls-Royce automobiles? However, there is also considerable doubt on the part of some economists, based on their reading of the data, that licensing does much to improve quality.

Next we look at price discrimination, a pricing strategy attractive to those who can use it.

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1 Economic theory may encourage an underestimation of the value of unions because it focuses on relationships of voluntary exchange, not on power relationships. In a modern economy market relations have been partially replaced by the hierarchical relations within the large corporation. There is a potential for abuse in the power relations that exist within the firm, and unions are a way to respond to this. Unions are more likely to be formed in organizations that have poor management-worker relations than in those where management-worker relations are harmonious.

Copyright Robert Schenk