ECN105 Contemporary Economic Issues

Lecture 3
Labour Market and Income Distribution
Lecture plan

• A brief review of the labour market

• Linking the labour market to income distribution
• Measuring inequality: the GINI coefficient
• The labour market-income distribution model in action
The Labour Market: a brief summary
 Labour Market Equilibrium
The equilibrium of the labour market is where the wage- and
price-setting curves intersect. This is a Nash equilibrium

 𝜆 𝑝 = Π +𝑊
Labour
supply
  Π 𝑊
𝜆= + Wage-setting
𝑝 𝑝 curve

Average product of labour, λ

 𝑊 Π  𝜆
Real wage

=𝜆 −  Π
𝑝 𝑝 𝑝
 𝑊 Price-setting curve
𝑝 X

 𝑊
𝑝

No work done: wage is too

low for adequate effort
0 Employment, N

Employed Unemployed
 Labour Market Equilibrium as a Nash Equilibrium

Taking the economy as a whole, at the intersection of the wage- and price-setting
curves:

• The firms are offering the wage that ensures effective work from employees at
least cost (that is, on the wage-setting curve). HR cannot recommend an
alternative policy that would deliver higher profits
• Employment is the highest it can be (on the price-setting curve), given the
wage offered. The marketing department cannot recommend a change in
price or output.
• Those who have jobs cannot improve their situation by changing their
behaviour.
• Those who fail to get jobs would rather have a job, but there is no way they
can get one—not even by offering to work at a lower wage than others.
 Feature of the economy (model): Involuntary unemployment

Unemployment = excess supply in the labour market

There will always be unemployment in labour market equilibrium

• No unemployment → zero cost of job loss → no effort

• Therefore some unemployment is necessary to motivate workers
• These are the involuntarily unemployed
Linking the labour market to income
distribution
 Labour market and income distribution

• The labour market model determines

• the level of employment, unemployment, and the wage rate
• the division of the economy’s output between workers (both employed and
unemployed) and employers
• the distribution of income in a simple economy in which there are just these
two classes (employers, who are the owners of the firms, and workers),
where some of the latter are without work.
 Labour market and income distribution

• Suppose an economy with 100 people

• 10 firms each owned by 1 individual
• Labour supply of 90 workers
• 80 employed
• 10 unemployed

• Average product of labour l = 1

• Equilibrium real wage rate w = 0.6
 Labour
The Labour Market
supply

1.0 Average product of

labour

profit
Real wage

A
0.6 Price-setting curve

Wage-setting wage
curve

0 Employment, N
40 80 90
 The Lorenz Curve
100

Cumulative share of income (%)

60

What is the GINI coefficient?

0
0 10 90 100

Unemployed Employed Owners

Cumulative share of the population

from lowest to highest income (%)
The Lorenz Curve
What is the GINI coefficient?
100
 𝐺𝐼𝑁𝐼 = 𝐴 𝐴
= =2 𝐴
𝐴 +𝐵 1+ 𝐵2 0.5
Cumulative share of income (%)

60  𝐵 = (0.8 × 0.6 ) = 0 .24

1
2
 𝐴 B2
 𝐵 = (0.6 +1 )× 0.1 =0 .08
2
2
B1
 𝐴 =0.5 − 0.24 − 0.08= 0.18

0  𝐺𝐼𝑁𝐼 =2 𝐴 = 0.18 × 2= 0.36

0 10 90 100

Unemployed Employed Owners

Cumulative share of the population

from lowest to highest income (%)
Exploring the GINI coefficient
 Exploring the GINI coefficient

  𝑟𝑒𝑎𝑙 𝑤𝑎𝑔𝑒 𝑝𝑒𝑟 𝑤𝑜𝑟𝑘𝑒𝑟 𝑤

𝑠=𝑤𝑎𝑔𝑒 𝑠h𝑎𝑟𝑒= =
𝑜𝑢𝑡𝑝𝑢𝑡 𝑝𝑒𝑟 𝑤𝑜𝑟𝑘𝑒𝑟 𝜆

u = fraction of population that is unemployed

n = fraction of population that is employed

w = real wage

s = w/l = the wage share received by workers

 Exploring the GINI coefficient

  𝐴 =0.5 − 𝐵= 0.5 − 𝐵 1 − 𝐵 2 − 𝐵3

 𝐵 = 1 𝑛𝑠
1
2
𝐵
  2=(1− 𝑢 − 𝑛) 𝑠

  = 1
𝐵 3 (1− 𝑢− 𝑛)(1− 𝑠)
2

  = 𝐵 +𝐵 + 𝐵 = 1 1
𝐵 1 2 3 ( 1− 𝑢− 𝑛 ) + ( 1− 𝑢 ) 𝑠
2 2
 Exploring the GINI coefficient
𝐺𝐼𝑁𝐼
  =2 𝐴=2 ( 0.5 − B )=1 −2 B

We know that:
 𝐵 = 1 ( 1 − 𝑢 − 𝑛 ) + 1 ( 1 − 𝑢 ) 𝑠
2 2
So:

 𝐺𝐼𝑁𝐼 =𝑢 +𝑛 − (1 − 𝑢 ) 𝑤
𝜆

What can we learn from this expression?

 Exploring the GINI coefficient
  𝑤
𝐺𝐼𝑁𝐼 =𝑢+𝑛 − (1 − 𝑢)
𝜆
• Class of employers gets smaller (u+n)↑
• The GINI coefficient increases and inequality worsens. The same amount of profit
is now shared among fewer employers who are becoming richer than before
• Increase in the wage share (w/l) ↑
• (Ceteris Paribus) this leads to a fall in the GINI and in a more equal distribution
• Firms are cooperatives
• There are no employers and workers keep all the output (w/l=1) then the GINI
reduces to:  𝐺𝐼𝑁𝐼 =2 𝑢+ 𝑛− 1
• With no unemployment u=0 then n = 1 and GINI = 0. Perfect equality
The labour market-income distribution model in action
 The Labour Market – Income distribution model in action
Labour
supply

1.0 l 100

Cumulative share of income (%)

profit
Real wage

A
0.6 60

Wage-setting wage
curve

0 0
40 80 90
0 10 90 100
Employment, N
Unemployed Employed Owners
What happens to income distribution if there is an
Cumulative share of the population
increase in the level of competition in the economy? from lowest to highest income (%)
Greater competition in the economy
• The wage setting curve is unchanged
• The price setting curve is affected by the greater level of competition:
• The demand curve becomes more elastic
• Firms will maximise prices at a lower price and, hence, greater output
• Greater output leads to higher employment
• The lower price level increases the real wage
• With productivity constant the end result is:
• A higher real wage
• An increase in employment (reduction of unemployment)
• An upward shift of the price setting curve
• A lower real profit for the firm (lower markup)
• In turn, income distribution will…..
 The Labour Market – Income distribution model in action
What happens to income distribution if there is an
increase in the level of competition in the economy? Labour
supply What is the new GINI coefficient?
100
1.0 l

New price-setting curve

Cumulative share of income (%)

(lower mark-up; wage share: 0.76) B
0.76 76

A
Real wage

0.6 60

Wage-setting
curve

0
0
50 0
80 83 90 7 10 90 100
Employment, N
Unemployed Unemployed Employed Owners

Cumulative share of the population

from lowest to highest income (%)
 The Labour Market – Income distribution model in action
 𝐺𝐼𝑁𝐼 = 𝐴 𝐴
= =2 𝐴
What is the new GINI coefficient? 𝐴 +𝐵 1+ 𝐵2 0.5
100

  = (0.83 × 0.76) = 0.3154

𝐵 1
2
Cumulative share of income (%)

76
 𝐵 = (0.76 +1 )× 0.1 =0 .088
2
2
60  𝐴
B2  𝐴=0.5 −0.32 −0.088=0 .0966

𝐺𝐼𝑁𝐼
  =2 𝐴 = 0.0966 × 2=0.19
B1 Or…
0  𝐺𝐼𝑁𝐼 =𝑢 +𝑛 − (1 − 𝑢 ) 𝑤
𝜆
0
7 10 90 100
𝐺𝐼𝑁𝐼
  =0.07+0.83 − ( 1 − 0.07 ) 0.76=0.19
Unemployed Employed Owners

Cumulative share of the population

from lowest to highest income (%)
 Next Week
Impact of automation on the labour market and income
distribution
Readings

Econ CORE – Unit 9 (9.8)