Figure 16.D.I. Effect of Labor Unions on Supply and Demand

16.d. Labor Unions

Labor Unions are the result of a successful unionization of workers. They are also a form of cartel because they change the labor market from operating at its competitive equilibrium (E). By effectively organizing, labor unions can make themselves the only suppliers of labor inputs and thus have some influence over the wage that the laborers are paid. Figure 16.d.i. shows the quantity of labor services demanded and supplied at various wage rates assuming there are neither monopsonies nor monopolies. In this competitive market, the labor market is at equilibrium point E where Lc workers are hired at a wage rate of Wc.

Figure 16.d.i. Effect of Labor Unions on Supply and Demand

When there is a labor union, the workers must look at the marginal revenue curve that is associated with the demand curve for its services in order to maximize a wage and employment level for its members. The marginal revenue curve represents the additional wages earned by all of the union members as each new union member joins. So the labor union can maximize the wages earned for its members by an employment level Lu, where the marginal revenue curve (MR) intersects the labor supply (S) curve. In figure 16.d.i. this is the point B. At the employment level Lu, the wage rate the unionized workers receive is Wu.

The area WuABF is the excess of the wage rate over the workers’ opportunity cost from zero to the quantity of labor services sold, Lu, by the labor union. In the above graph, we see that fewer workers end up being employed when there is a labor union than when there is just a competitive market. This is based on the ideal that unions are formed to maximize the total benefit to its members, not the number of workers having jobs. Area AEB is the dead weight loss to society created by the labor union by restricting labor and raising the wage rate. This is an area of debate among economists as to the effectiveness of these “legalized cartels.” They could potentially gain the area AEB but it is not of interest to labor unions as they supposedly value the incremental worker’s contribution to the total wage bill of the union rather than the value of a single worker’s output.

Do labor unions make workers more productive? On one hand, labor unions provide a “voice” for workers and an established avenue to report grievances that may make them feel more satisfied. And when workers are more satisfied, they have a higher level of productivity and thus the height of the demand curve shifts up (all other things equal). There is some empirical evidence to support this but there is also some that negates it as a viable theory. Just because a worker is more productive at the union employment level of Lu than the competitive market level of Lc, does not imply that is was the union that necessarily made the worker more productive.

Review Question

1) The fifty teachers at CountryDayElementary School are feeling undervalued and want to receive higher wages for all of their time and effort. They are currently receiving a competitive market wage of $20/hour but want to increase their wages. What would they have to do to move from a $20/hour wage to a higher wage? Is it possible? And what are the effects on society? Show a graph with your explanation

Answer

The 50 teachers can create/join a teachers union. This is a form of cartel so the labor demand will move from the competitive market equilibrium of point E where there are 50 workers receiving a wage of $20/hour to a new amount of labor that is less than 50 workers employed (point where the MR and S curves cross) but receiving a higher wage rate than $20/hour (point A on graph. So yes, it is possible to unionize the teachers and thus increase the wage rate, but at the same time, the number of teachers employed at this new wage will be less than before. This unionization also creates a DWL to society that consists of triangle AEB that cannot be captured with this union in place.