Perfect Competition in Labor Markets (Wonkish)

The IMF recently lambasted the U.S. for it’s low minimum wage that’s below poverty lines. Meanwhile, members of congress are suggesting trashing the minimum wage all together. So what exactly will happen if minimum wage goes away? What if labor markets were “perfectly competitive” like the conservatives suggest they should be?

Microeconomics tells us that the rules of perfect competition puts downward pressure on prices. In other words, the more (perfect) competition, the lower the prices, and thus, the lower the profits. This is because in order for companies to maximize profit, they have to lower prices to make Marginal Revenue equal Marginal Cost, as in the following curve:

screen-shot-2011-01-26-at-10-10-00-am

In other words, if 20 companies want to sell me a broom, and all brooms are the same, and I find the same utility no matter which broom I buy, then I’m going to buy the lowest price broom, cutting into the profits of ALL companies selling brooms – except the one I actually buy the broom from (assuming that they have engaged in profit maximization of MC=MR).

Perfect competition naturally lowers profits by naturally lowering prices. And I’m not the only one buying a broom (more on that in a minute), which makes sure that competition maintains itself, by the aggregate demand forcing prices down at every broom stores.

But what happens when a labor market is perfectly competitive, as in the elimination of minimum wage? Theory says that the effects should be the same. The only difference is that the worker, or the labor aggregate is the market – looking to sell his/her labor instead of a firm selling brooms.

So let’s say that there are 20 cashiers, all having the same skills, same experience, etc. And let’s say that one broom store, with no wage constraints (no minimum wage) needs one cashier. Who gets the job? Perfect competition says that the one who is willing to work for the lowest wage gets the job – even if it’s for 50 cents and hour; or worse, commission.

300px-Monopsony-static-partial-equilibrium

It’s also called a Monopsony; where one “buyer” (the broom store) interacts with many sellers (20 cashiers).

So adding labor, the shift from L to L` automatically increases MC, and lowers MRP (profit). The only way for the broom store to maximize profit (A) would be to lower MC (which he/she may or may not be able to control), or take the low-ball price on wages/commission (M).

In other words, if there was no minimum wage, theoretically, people would race to the bottom to sell their labor for the lowest wage in order to have something. Add in that there are currently more workers than jobs, which makes a Monopsony more likely, and it’s a faster race to the bottom.

And this is a perfect example too, considering that 44% of the job growth since the “recovery” has been in law wage jobs. How much skill does one need to sell a hamburger, or run a cash register? It makes the labor market that much more perfectly competitive by assuring that everyone has the same skill set – selling/cashing things in retail.

How likely are people to be able to live when bidding their own wages in a perfectly competitive labor market with no constraints? Some people say a minimum wage constrains competition. Theoretically is does. More than that though, it puts a floor on labor bidding wars so that people don’t starve, and have a roof over their head. Minimum wage is no longer doing that, according to the IMF, so what’s the point? Good question.

 

 

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