Roles of Labour Union in Factor Market

Introduction

By imperfect factor market we mean to say that owners of factor inputs enjoy market power to determine the factor price and to control its supply. In the labour market, imperfection arises when workers enjoy bargaining power by forming labour unions to raise their demand for wages above the equilibrium rate, to restrict the supply of unionized labour and to demand for other job-related facilities for the welfare of the workers.

In other words, a labour union is an organization in which all the workers take a collective decision rather than competing with each other. That is, in the factor market labour union acts as a monopolist. Hence, wage in the market depends on the different goals of the labour union.

Among several goals of a labour union, we focus here on the following three important goals by which the union determines the wage rate. These are the maximization of employment, the maximization of the total wage bill and the maximization of the total gains to the union as a whole.

Interaction of Labour Unions with Firms under Different Market Structures

Competitive Firm and Labour Union:

When perfect competition prevails in the product market, the demand curve for labour is given by the sum of individual firms’ demand curve for labour or aggregate 𝑉𝑀𝑃_𝐿 curve shown in figure-1. This demand curve 𝐷_𝐿 is also the average revenue curve (𝐴𝑅_𝑈) for labour unions. The marginal revenue (𝑀𝑅_𝑈) curve is drawn to find the maximized level of the wage bill and total gains of the labour union. The supply curve of labour 𝑆_𝐿 is constructed by taking the horizontal sum of individual labour.

The intersection of aggregate demand and supply of labour determines the highest level of employment at wage rate 𝑤₀. Therefore, if the objective of the labour union is to maximize the employment level, then it will demand the wage rate 𝑂𝑤₀, and the employment will be 𝑂𝐿₀ units of labour.

On the other hand, the labour union wants to maximize the total wage bill, the equilibrium will take place at point 𝑒₁ in figure-1 where 𝑀𝑅_𝑈 is zero, and 𝑇𝑅_𝑈 is maximum, and the union will supply 𝑂𝐿₁ unit of labour at the wage rate 𝑂𝑤₁. In order to maximize the total gains to the labour union, the wage is set at the point where the marginal revenue of the labour union equals to the marginal cost (represented by the supply curve 𝑆_𝐿). This is shown by the new equilibrium point 𝑒₂.

It is now required to examine the fact that with these targets whether the labour union is benefitted or not. We begin with the equilibrium under a perfectly competitive labour market that happens at point 𝐸 in figure-1. The equilibrium wage rate is 𝑤₀, and the corresponding profit maximizing level of employment is 𝑂𝐿₀ units of labour. This is the highest amount of labour a firm can hire.

Assume that a labour union is formed for the betterment of the labour force. Since beyond 𝑂𝐿₀ units, no firm can hire extra labour, and labour unions cannot increase employment. Therefore, its only alternative goal is to bargain for a higher wage rate. The higher wage rate can be set through the process of maximization of the wage bill, or maximization of total gains or any other bargaining solution.

Suppose that the union decides to set the wage at 𝑊₂ (i.e. at this wage rate, total gain to the labour union is maximized). We have a kinked supply curve 𝑊₂𝐹𝐺𝑆_𝐿 at this new wage rate set by the union. At this new wage rate, 𝑊₂ each firm in the industry reduces the demand for labour, and the market demand for labour is reduced to 𝑂𝐿₂ units. There exist 𝐹𝐺 units of unemployed labour at this new wage rate. Unless the gain from this wage increase is not distributed among the workers who lost their jobs, the labour union’s decision to raise wages will become vulnerable to them.

Note that the union’s bargaining power depends on the elasticity of demand for labour. If the demand for labour is inelastic, the union can enjoy its maximum market power to raise wages. On the other hand, if the demand for labour is highly elastic, with the rise in wage rate, the total wage bill will fall and the entire labour force other than those who are able to retain their jobs under labour union will be worse-off.

Interaction Between Labour Union and Monopsonist Firm:

When a firm enters in the labour market as a single buyer or monopsonist and the labour market is unionised, exploitation of labour cannot be fully eliminated. However, the additional exploitation due to the monopsony power of the firm can be eliminated. This implies that monopsonist exploitation will be reduced to monopolistic exploitation. The labour union cannot remove monopolistic exploitation. This is shown in figure-2 (a)-(b).

The presence of both monopsonist firms and labour unions in the factor market implies that there exists a bilateral monopoly situation, and consequently there will be indeterminacy of wage and employment. A labour union can either increase the wage rate or increase employment to increase its total wage bill. In order to avoid the indeterminacy problem of a pure bilateral monopoly situation, we assume that the labour union will not maximize its total gain; rather, it will focus on attaining the above said two alternative goals.

Assume that initially there is no labour union, and therefore, the equilibrium is attained at a point 𝐸 where 𝑀𝐸_𝐿 curve intersects the 𝑀𝑅𝑃_𝐿 curve shown in figure-2(a). The monopsonist firm will now hire 𝑂𝐿_𝑀𝑆 units of labour and will pay wage 𝑊_𝑀𝑆. Now assume that labour is unionised and assume also that the goal of labour union is to maximise the level of employment. The union, therefore, sets wage rate 𝑊̅̅̅𝑀̅̅ at which the 𝑀𝑅𝑃_𝐿 curve cuts the 𝑆_𝐿 curve. Since below 𝑊̅̅̅𝑀̅̅ workers are not ready to work, the supply curve of labour becomes a kinked curve 𝑊_𝑀𝐵𝑆_𝐿, while the marginal expenditure of labour curve (𝑀𝐸_𝐿) curve has two discontinuous segments 𝑊̅̅̅𝑀̅̅𝐵 and 𝐹𝑀𝐸_𝐿. At the equilibrium, the level of employment increases to 𝐿_𝑀. Since both wage rate and level of employment increase, the wage bill increases from 𝑂𝑊_𝑀𝑆𝐴𝐿_𝑀𝑆 to 𝑂𝑊̅̅̅𝑀̅̅𝐵𝐿_𝑀. As each worker gets a wage equal to its 𝑀𝑅𝑃_𝐿, there is no exploitation that is solely attributable to the monopsony power of the firm. However, monopolistic exploitation still exists.

Now, the labour union wants to achieve the goal of maximum wage at the initial level of employment 𝐿_𝑀𝑆 by setting the wage rate equal to̅ 𝑊̅̅̅𝑈̅ shown in figure-2(b). At this higher wage rate, the supply curve of labour ̅𝑊̅̅𝑈̅𝐸𝐶𝑆_𝐿 becomes a kinked at point 𝐶, and there is resulting discontinuity 𝑀𝐸_𝐿 curve. It is divided into two discontinuous parts 𝑊𝐸𝐶 and 𝐺𝑀𝐸_𝐿. The equilibrium is obtained at point 𝐸, where the 𝑀𝑅𝑃_𝐿 equals to the new 𝑀𝐸_𝐿. At this equilibrium, the firm has to pay a wage rate 𝑊̅̅̅𝑈̅̅ without reducing the employment from the initial level of employment 𝐿_𝑀𝑆. The wage bill consequently increases from 𝑂𝑊_𝑀𝑆𝐴𝐿_𝑀𝑆 to 𝑂̅𝑊̅̅𝑈̅̅𝐸𝐿_𝑀𝑆. Since 𝑊̅̅̅𝑈̅̅ equals to 𝑀𝑅𝑃_𝐿, the exploitation of labour solely due to the monopsony power of the firm is eliminated, but exploitation due to the monopoly power enjoyed by the firm in the product market cannot be wiped out by the labour union. If the labour union wants to increase the wage rate further above ̅𝑊̅̅𝑈̅̅, the wage bill will increase when 𝑀𝑅𝑃_𝐿 curve is relatively inelastic otherwise, the wage bill declines.

Hence, it can be summarized that when there is a single buyer firm in the labour market, the labour union can attain higher wages at the expense of lower employment. The benefits of this higher wage enjoyed by all members of the union depend on the elasticity of demand for labour. The labour union can eliminate only the exploitation solely attributable to the monopsony power of the firm but cannot eliminate monopolistic exploitation of labour.