CHAPTER 11

11-1. Suppose the firms labor demand curve is given by: w = 20 - 0.01 E, where w is the hourly wage and E is the level of employment. Suppose also that the unions utility function is given by U = w E. It is easy to show that the marginal utility of the wage for the union is E and the marginal utility of employment is w. What wage would a monopoly union demand? How many workers will be employed under the union contract?

Utility maximization requires the absolute value of the slope of the indifference curve equal the absolute value of the slope of the labor demand curve. For the indifference curve, we have that
MU E w = . MUw E

The absolute value of the slope of the labor demand function is 0.01. Thus, utility maximization requires that
w = .01 . E

Substituting for E with the labor demand function, the wage that maximizes utility must solve

w = 0.01 , 2,000 100 w which implies that the union sets a wage of $10, at which price the firm hires 1,000 workers.
11-2. Suppose the union in problem 1 has a different utility function. In particular, its utility function is given by: U = (w - w*) E where w* is the competitive wage. The marginal utility of a wage increase is still E, but the marginal utility of employment is now w w*. Suppose the competitive wage is $10 per hour. What wage would a monopoly union demand? How many workers will be employed under the union contract? Contrast your answers to those in problem 1. Can you explain why they are different?

76

Again equate the absolute value of the slope of the indifference curve to the absolute value of the slope of the labor demand curve:
MU E w w* = = 0.01 . MU w E Setting w* = $10 and using the labor demand equation yields: w 10 = 0.01 . 2,000 100 w Thus, the union demands a wage of $15, at which price the firm hires 500 workers. In problem 1, the union maximized the total wage bill. In problem 2 the utility function depends on the difference between the union wage and the competitive wage. That is, the union maximizes its rent. Since the alternative employment pays $10, the union is willing to suffer a cut in employment in order to obtain a greater rent.
11-3. Using the model of monopoly unionism, present examples of economic or political activities that the union can pursue to manipulate the firms elasticity of labor demand. Relate your examples to Marshalls rules of derived demand.

Marshalls rules state that the elasticity of labor demand is lower the 1. lower is the elasticity of substitution; 2. lower is the elasticity of demand for the output; 3. lower is labors share of total costs; and 4. lower is the supply elasticity of other factors of production. Consider two examples: innovations and picket lines. Unions are notoriously bad at allowing firms to introduce (labor saving) innovations in their factories. The long shoremen on the west coast recently struck, because they were unwilling to let cargo crates be identified with bar codes. (The union wanted a union worker to record all movements of crates with pencil and paper.) Thus, the union was pursuing a policy of limiting the supply of other factors of production (rule 4). In a similar vein, when on strike, unions picket the firm in order to decrease the ability of the firm to hire scabs (rule 1).

77

11-4. Suppose the union only cares about the wage and not about the level of employment. Derive the contract curve and discuss the implications of this contract curve.

The utility function U = U(w) implies that the unions indifference curves are horizontal lines, so that the contract curve coincides exactly with the firms labor demand curve (D).

Dollars

U D Employment

11-5. A bank has $5 million in capital that it can invest at a 5 percent annual interest rate. A group of 50 workers comes to the bank wishing to borrow the $5 million. Each worker in the group has an outside job available to him or her paying $50,000 per year. If the group of workers borrows the $5 million from the bank, however, they can set up a business (in place of working their outside jobs) that returns $3 million in addition to maintaining the original investment. (a) If the bank has all of the bargaining power (that is, the bank can make a take-it or leave-it offer), what annual interest rate will be associated with the repayment of the loan? What will be each workers income for the year?

If the bank has all of the bargaining power, it will pay each worker exactly their reservation wage, i.e., $25,000. The total cost of this is $2.5 million. Thus, the firm will claim the remaining $500,000 by imposing a 10 percent interest rate as $500,000 is 10 percent of the original $5 million.
(b) If the workers have all of the bargaining power (that is, the workers can make a take-it or leaveit offer), what annual interest rate will be associated with the repayment of the loan? What will be each workers income for the year?

If the workers have all of the bargaining power, they will pay the bank its reservation value, i.e., an interest rate of 5 percent. When it does this, the 50 workers receive $3 million less the 5 percent interest of $250,000 for a total of $2.75 million. Split evenly among the 50 workers, this leaves each worker with a yearly income of $55,000.

78

11-6. Consider a firm that faces a constant per unit price of $1,200 for its output. The firm hires workers, E, from a union at a daily wage of w, to produce output, q, where q = 2E. Given the production function, the marginal product of labor is 1/E. There are 225 workers in the union. Any union worker who does not work for the firm can find a non-union job paying $96 per day. (a) What is the firms labor demand function?

The labor demand function, or the marginal revenue product of labor, is MRPE = MR MPE = 1200 / E .
(b) If the firm is allowed to specify w and the union is then allowed to provide as many workers as it wants (up to 225) at the daily wage of w, what wage will the firm set? How many workers will the union provide? How much output will be produced? How much profit will the firm earn? What is the total income of the 225 union workers?

If the firm offers w < $96, no workers will be provided. This would leave the firm with no output and no profit. The workers would all receive $96 per day, making their total daily income $21,600. If the firm offers a wage of w > $96, all 225 workers will be provided. These 225 workers would produce 30 units of output. The firm would then earn a profit of 30($1,200) 225w. Profit, therefore, is maximized when w is minimized subject to the constraint. If the union would supply all 225 workers at a wage of $96, for example, the firm would offer w = $96 and earn a daily profit of $14,400. The total daily income of the 225 workers would remain at $21,600. If the firm needs to offer strictly more than $96 per day to attract workers, it would offer a daily wage of $96.01. All 225 workers would work for the firm, making 30 units of output. The firms daily profit would be $14,397.75. And the total daily income of the 225 workers would be $21,602.25.
(c) If the union is allowed to specify w and the firm is then allowed to hire as many workers as it wants (up to 225) at the daily wage of w, what wage will the union set in order to maximize the total income of all 225 workers? How many workers will the firm hire? How much output will be produced? How much profit will the firm earn? What is the total income of the 225 union workers?

79

The spreadsheet looks like the following, where the union specifies the wage, labor demand comes from part (a), and everything else follows naturally:
wage $96 $97 $98 $99 $100 $190 $191 $192 $193 $194 $195 Labor Demand 156.25 153.04 149.94 146.92 144.00 39.89 39.47 39.06 38.66 38.26 37.87 Labor Costs $15,000.00 $14,845.36 $14,693.88 $14,545.45 $14,400.00 $7,578.95 $7,539.27 $7,500.00 $7,461.14 $7,422.68 $7,384.62 Output 25.00 24.74 24.49 24.24 24.00 12.63 12.57 12.50 12.44 12.37 12.31 Price $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 Revenue $30,000.00 $29,690.72 $29,387.76 $29,090.91 $28,800.00 $15,157.89 $15,078.53 $15,000.00 $14,922.28 $14,845.36 $14,769.23 Profit $15,000.00 $14,845.36 $14,693.88 $14,545.45 $14,400.00 $7,578.95 $7,539.27 $7,500.00 $7,461.14 $7,422.68 $7,384.62 Union Daily Income $19,200.00 $19,353.04 $19,499.88 $19,640.77 $19,776.00 $22,949.58 $22,949.90 $22,950.00 $22,949.90 $22,949.60 $22,949.11

Thus, the union sets a daily wage of $192. The firm responds by hiring 39.06 workers, who produce 12.5 units of output. The firm earns a daily profit of $7,500, while the 225 union workers earn a total of $25,297.92 each day.
11-7. Suppose the unions resistance curve is summarized by the following data. The unions initial wage demand is $10 per hour. If a strike occurs, the wage demands change as follows: Length of Strike: 1 month 2 months 3 months 4 months 5 or more months Hourly Wage Demanded 9 8 7 6 5

Consider the following changes to the union resistance curve and state whether the proposed change makes a strike more likely to occur, and whether, if a strike occurs, it is a longer strike. (a) The drop in the wage demand from $10 to $5 per hour occurs within the span of 2 months, as opposed to 5 months.

If the union is willing to drop its demands very fast, the firm will find it profitable to delay agreement until the wage demand drops to $5. A strike, therefore, is more likely to occur. If $5 is the lowest wage the union is willing to accept, the strike would probably last 2 months.
(b) The union is willing to moderate its wage demands further after the strike has lasted for 6 months. In particular, the wage demand keeps dropping to $4 in the 6th month, $3 in the 7th month, etc.

If the union is willing to accept even lower wages in the future, some firms will find it optimal to wait the union out. Thus, strikes will be more likely and last longer.

80

(c) The unions initial wage demand is $20 per hour, which then drops to $9 after the strike lasts one month, $8 after 2 months, and so on.

Conditioning on a strike occurring, the length of strike will be unchanged as the resistance curve after the initial demand stays the same. Of course, the probability of a strike occurring increases when the initial demand increases.
11-8. (a) Would you expect unions to be more willing to call a strike during good economic times or bad economics times? Explain.

This is an open question much empirical evidence suggests that strikes are procyclical a conclusion that the model of job search supports. During good economic times, there are many good jobs available, searching for jobs is relatively easy, and the probability of securing a job is quite high. In short, the nonunion option is quite attractive. During such times, therefore, the union may be a tough negotiator, and this tough stance may lead to more strikes being called. (This doesnt explain, though, why the firms are also tough negotiators during such times.) The opposite happens during bad economic times. Namely, jobs are scarce, they are difficult to find, and searching is costly. The non-union option, therefore, is not very attractive. Consequently, the union leadership may be more willing to accept a deal. This softer stance, therefore, may lead to fewer strikes being called.
(b) Does Table 627 of the 2002 U.S. Statistical Abstract provide evidence to support your answer to part (a)? What is the single overriding pattern in this table?

There is some evidence that strikes are more prevalent in good times than bad (compare the 1960s to the early 1970s), but there was much more strike activity in the late 1970s and early 1980s than in the mid to late 1980s. The single most obvious pattern in the table, however, is that as union membership steadily fell over this time period, the level of strike activity also fell. The average percent or working time lost to a strike was about 12 percent, 10 percent, 4 percent, and 2 percent for the 1960s, 1970s, 1980s, and 1990s respectively.
11-9. Suppose the value of the marginal product of labor in the steel industry is VMPE = 100,000 E dollars per year, where E is the number of steel workers. The competitive wage for the workers with the skills needed in steel production is $30,000 a year, but the industry is unionized so that steel workers earn $35,000 a year. The steelworkers union is a monopoly union. What is the efficiency cost of the union contract in this industry?

If the steel industry were to pay the competitive wage to its workers, it would employ 70,000 workers, because at this level the VMP of the last employee equals the competitive wage. Under the union wage, however, the industry only hires 65,000 workers. The efficiency cost of the union, therefore, is ()($35,000 $30,000)($70,000 $65,000) = $125 million per year.

81

11-10. Suppose the economy consists of a union and a non-union sector. The labor demand curve in each sector is given by L = 1,000,000 20w. The total (economy-wide) supply of labor is 1,000,000, and it does not depend upon the wage. All workers are equally skilled and equally suited for work in either sector. A monopoly union sets the wage at $30,000 in the union sector. What is the union wage gap? What is the effect of the union on the wage in the non-union sector?

In a competitive economy, the wage would be the same in the two sectors, and its value would be such that the total labor demand LD = 2 (1,000,000 20wC) equaled total labor supply. The solution to the equation 2 (1,000,000 20wC) = 1,000,000 is wC = $25,000. If the union wage is set at $30,000, the union sector employs 400,000 workers. The remaining 600,000 must be employed in the non-union sector, which will happen if the wage in the non-union sector is (1,000,000 600,000)/20 = $20,000. Hence, the wage gap between the union and the non-union sectors equals $10,000, or 50 percent of the non-union wage.
11-11. Consider Table 628 of the 2002 U.S. Statistical Abstract. (a) How many workers were covered by a union contract in 1983? What percent of the workforce was unionized?

In 1983, 20.532 million workers (23.3 percent of all workers) were covered by a union contract in the U.S.
(b) How many workers were covered by a union contract in 2001? What percent of the workforce was unionized?

In 2001, 17.878 million workers (14.8 percent of all workers) were covered by a union contract in the U.S.
(c) Decompose the changes from part (a) to part (b) in terms of public- and private-sector workers and unions.

This dramatic change in union coverage masks an even deeper pattern in union coverage namely that public-sector unions have been growing in absolute numbers and holding their own in percent coverage, while the private-sector unions have experienced sharp decreases in their enrollments. The number of public-sector workers covered by a union contract, for example, increased from just over 7 million in 1983 to almost 8 million in 2001. The percent of public-sector workers who were members of a union held constant over this time span at roughly 37 percent, while the percent of public-sector workers covered by a union contract fell slightly from 45.5 percent in 1983 to 41.7 percent in 2001. On the other hand, the number of private-sector workers covered by a union contract decreased from 13.4 million in 1983 to only 9.9 million in 2001. The percent of private-sector workers covered by a union contract also fell drastically, from 18.5 percent in 1983 to just 9.7 percent in 2001.

82

11-12. Consider table 618 in the 2002 U.S. Statistical Abstract. (a) Calculate the union wage effect. Calculate the union effect on total benefits. Calculate the union effect on total compensation.

The union effects are simply the ratio of the union amount divided by the non-union amount: Wage effect: $19.33 / $15.38 = 1.257 percent. Benefit effect: $10.09 / $5.41 = 1.865 percent Total compensation effect: $29.42 / $20.79 = 1.415 percent.
(b) Note that for most categories, retirement and savings increases total compensation by about 60 to 80 cents per hour, with roughly two-thirds of this expense coming in defined contribution retirement plans. In contrast, retirement and savings adds $1.64 to the hourly compensation of union workers, and over 70 percent of this comes in the form of defined benefit pension plans, not defined contribution. What is the difference between defined benefit and defined contribution plans? Why might a union prefer (and be able to negotiate) more compensation in defined benefit plans than defined contribution plans?

A defined benefit plan specifies the retirement benefit as a fixed dollar amount. For example, if someone receives 50 percent of their last annual income as their annual pension, this is a defined benefit plan. In contrast, a defined contribution plan specifies the amount of savings into a retirement plan the firm will make. The amount of benefit eventually received by the worker depends on how well the money is invested until retirement. It is generally thought the workers prefer DB plans (though this doesnt need to be the case). DB plans put the risk on the part of the firm, while DC plans put the financial risk on the part of the worker. (The workers at Enron, for example, lost huge amounts of retirement savings not only because they were in a DC plan but also because they were forced to keep most of their contributions as Enron stock.) As unions tend to work in large firms, they may be more able than other workers to negotiate a DB plan.

83