Revision presentation from 2012 on aspects of labour market failure

1. Labour Market Failure
A2 Economics

2. Market Failure – The Labour Market
• What is market failure?
• The failure of the market mechanism to
reach a socially efficient and equitable
allocation of scarce resources
• Failure can lead to
– Welfare losses for society
– A misallocation of resources
– Worsening of economic performance
• Higher unemployment
• Slower growth
– Social problems – negative externalities
High marks at A2 for
finding links between
micro and macro topics!

3. The most important market in the economy?

4. Potential causes of market failure
• 1. Labour immobility and skills gaps
• 2. Disincentives to work – “traps”
• 3. Discrimination in the labour market
• 4. Monopsony power of employers
• There are other causes – but time only allows me to focus on these
four and then on different options for government intervention

5. Labour immobility
• Occupational immobility
– (i) Skills mismatch
– (ii) Loss of skills and motivation
from long term unemployment
– (iii) Artificial barriers to entry
• Lawyers
• Medics
• Accountants

6. Geographical immobility
• (i) Regional house price
differences
• (ii) Family and social ties
• (iii) Language barriers
• (iv) Differences in living costs
• Which is the world’s most
expensive city to live in?
World’s most expensive
cities in 2008
1. Moscow
2. Seoul
3. Tokyo
4. Hong Kong
5. London
6. Osaka
7. Geneva
8. Copenhagen
9. Zurich
10.Oslo
11.New York

7. Skills gaps
• Market often
under-provides
skills training
• The free-rider
problem
• Lack of finance
for people
wanting to invest
in ‘human capital’

8. Evaluation: Why does immobility matter?
• (a) Structural unemployment – has economic and social
costs
• (b) Makes the labour market less flexible
• (c) Persistent labour shortages in some areas and
surpluses in others
– Creates inflationary pressures on wages
– Forces up the costs of infrastructure projects e.g. Olympics
– Depresses income in regions of high unemployment
– Hits the provision of public services e.g. NHS dentists
• (d) Rising inequality / relative poverty
• (e) Deepens the regional economic divide
• (f) Damages the potential output of the economy

9. Disincentives - Traps
• For many people there are deep-rooted
disincentives to look for and accept paid work
• Poverty trap
• Unemployment trap
• The two are linked …. And you wont be penalised for assuming that
they are the same!

10. Poverty Trap
• Earning extra income may have little positive effect on a
person’s disposable income
– You earn more money…. But
1. Start paying income tax and national insurance
2. Start to lose income-related welfare benefits
3. Add in costs of childcare and travel to work expenses
• Result is that the effective marginal rate of tax might be
very high (perhaps > 75%)
• Paradox: Poorer people face higher tax rates than the
rich
• Consequences: Fewer people in work ►risk of poverty

11. Discrimination in the labour market
• Race
• Gender
• Height
• Weight
• Age
• Ethnicity
• Religion
• Sexual preference
• Other forms of discriminatory behaviour

12. Labour market discrimination

13. Discrimination
• Often reflects deep-seated prejudice
– Glass-ceilings
• But also the result of information failures
– Difficulties in measuring and monitoring people’s
contribution at the workplace
– So employers fall back on prejudice as a proxy
• Requires legislation and enforcement
• And changes in social values and tolerance

14. Using analysis diagrams in the exam
Employment of
group A
Wage
MRPL
MRPL Dis
Lab Supply
We
Wd
EeEd

15. Using analysis diagrams in the exam
Employment of
group A
Wage
MRPL
MRPL A
Lab Supply
Employment of
group B
Wage
MRPL
MRPL B
Lab Supply
We
Wd
EeEd
We
Ee
Wm
Ew

16. Monopsony power
• Major (dominant)
employers in an industry
or a local town might use
their ‘buying power’ to
drive wages below a level
that might exist in a more
competitive market.
• Examples:
• Gang masters
• Public sector employers
• Employment agencies
• Major employer in a local
town
• National health service
• Royal Mail

18. Monopsony analysis
Employment of labour (E)
Wage rate £
Marginal revenue product
Average cost of labour
Marginal cost of labour
E1
£180
£350

19. Workers may get paid less than their MRPL
Employment of labour (E)
Wage rate £
Marginal revenue product
Average cost of labour
Marginal cost of labour
E1
£180
£350

20. How a minimum wage might create jobs!
Employment of labour (E)
Wage rate £
Marginal revenue product
Average cost of labour
Marginal cost of labour
E1
£180
£350

21. How a minimum wage might create jobs!
Employment of labour (E)
Wage rate £
Marginal revenue product
Average cost of labour
Marginal cost of labour
E1
£180
£350
Pay Floor = £220Pay Floor

22. How a minimum wage might create jobs!
Employment of labour (E)
Wage rate £
Marginal revenue product
Average cost of labour
Marginal cost of labour
E1
£180
£350
Pay Floor = £220Pay Floor
E2

23. Government intervention & market failure
• Intervention
justified because
1. Market failure
causes loss of
efficiency
2. On grounds of
equity
3. Key evaluation is
whether the
intervention works!

24. Government intervention
• Policies to protect the rights of trade unions to be recognised at work
• Investment in education and training
– Modern apprenticeships
– Incentives to stay on in sixth form
• Legislation
– National minimum wage
– Immigration points system
– Licensing of gang masters
– Equal Pay Act and other laws to protect people’s rights at work
• Reform to taxation and benefits systems
• Measures to make housing more affordable
• In the exam
• Avoid being excessively political / extreme in your answers
• Always have costs and benefits of each policy to hand for evaluation

25. Tutor2u
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