Chapter 15-1

Chapter Fifteen

Wage and Employment Determination Under Collective Bargaining

Modeified from slides created by: Erica Morrill

Chapter 15-2

Chapter FocusUnion behaviour Interaction between firms and unions Inefficient production decisions Inefficient union practicesBargaining power

Chapter 15-3

Theory of Union BehaviourUnions attempt to maximize objectives

given economic constraints Ability to characterize preferences of

unions is difficult

Chapter 15-4

Union ObjectivesUtility is a positive function of wage rate

(W) and employment (E): u(W,E) Indifference curve is downward sloping

higher wage is needed to compensate for lower employment

Curves have a convex shape diminishing marginal rate of substitution

Chapter 15-5

DL

Figure 15.1 Union Objectives and Constraints

Real WageRate

WP

Wa

P

Employment E

a2

a1

U0 a3

U2

a0

U1

Chapter 15-6

Special Cases of Objective Functions

Maximize the Wage rate indifference curves are horizontal straight lines

Maximize Employment indifference curves are vertical straight lines

Maximize the (real) wage bill Indifference curve is downward sloping and convex to

the origin (disregards alternative wage rate) Maximize economic rent

curve out from the intersection of alternative wage Maximize total union utility: Lu(w)+(N-L)u(Wa).

Chapter 15-7

Additional ConsiderationsDeriving union objectives is simplest

when: preferences are homogeneous leaders are constrained by democratic

decision-making processes union membership is exogenously

determined

Chapter 15-8

Monopoly Union Model Unions negotiate wages taking into account

the consequences The firm decides the employment level

maximizing profits given W set by the union, which yield the demand for labor function, DL .

DL curve is analogous to a budget constraint

Program: Max u(W,E), subject to DL curve

Equilibrium is the tangent of the iso-utility curve and DL curve

Chapter 15-9

Firms Iso-profit CurvesCombinations of wage and employment

of equal profits, .

Higher profits on lower curvesFirm cannot pay wages below the

alternative wageWage will lie between the alternative

wage rate and the bargaining wage

Chapter 15-10

Figure 15.4 The Firm’s and Union’s Preferred Wage-Employment Outcomes

E

W

DL

U*Iu

0=0W0

Wu

*

IfWf = Wa

Chapter 15-11

Relaxing the Demand Constraint Union’s attempt to alter the constraint in their favor

increasing labour demand (thus increasing E) making demand more inelastic (thus resulting in higher

W and minor job loss) Restricting substitution possibilities

collective bargaining influencing public policy

Influence product market supporting quotas, tariffs and restrictions on foreign

competition

Chapter 15-12

Efficient Wage and Employment ContractsNegotiating over wage and employment

is mutually advantageous Pareto-efficient wage-employment

outcomes union’s indifference curve tangent to the

firms iso-profit curve

Chapter 15-13

Figure 15.5 Efficient and Inefficient Wage-Employment Contracts

DL

A

W

E

B

A’A’’

C

C’Wa

Chapter 15-14

Contract Curve

Locus of the Pareto-efficient wage-employment outcomes

Union cares about wages and employment

CC must lie to the right of DLcurve

Firms and unions are better off negotiating an outcome on the contract curve

Moving up on the CC makes unions better off Moving down makes the firm better off

Chapter 15-15

Efficient Versus Inefficient ContractsMonopoly union model (inefficient)

firm unilaterally sets employmentContract curve (efficient)

negotiate over wage and employment

Chapter 15-16

Figure 15.6 Inefficient and Efficient Contracts

E

W

C’

C

DL

Chapter 15-17

Theory of BargainingPredicting the outcome and explaining

depend factors Common features

Bargaining over a set of possible outcomes Minimum for each party Voluntary agreement Neither will agree to an outcome worse

than minimum

Chapter 15-18

Figure 15.7 The Nash Bargaining Solution

F

U

A

NU0

fNd

T

Max V=(U-U0)*(F-F0) The Nash solution

F0

Chapter 15-19

Solutions to the Sequential Bargaining ProblemRubinstein’s Theory (sequential

bargaining model) some concepts of non-cooperative game

theory bargainers take turns making offers

sequentially counter offers can be made utility shrinks in each round (reflecting

discount factors)

Chapter 15-20

BUB

fB f1f2fR

UR

R

Figure 15.8 The Rubinstein Solution to the Bargaining Problem

F

U

F

RU1

f1d

df4

U0

Rubinstein’s Solution Effect of delay Costs

U4

f3

f2f3fR

UR

U2

Bargaining lasts for 3 rounds: u-f-u3rd round: u offers U0

2nd

round: f offers C; 1st

round: u offers R

C

A

Sequence: f-u-f3rd round: f offers fB

2nd

round: u offers B;

1st

round: f offers A

Chapter 15-21

End of Chapter Fifteen