Question

a) Illustrate the firm’s and union’s preferred wage-employment outcomes and the bargaining range.

b) In separate diagrams, demonstrate 2 possible methods that the union can use to enhance the set of available options by altering the constraint; provide policy suggestions on how to put the methods into practice.

Answer 1

The view taken in the economic literature is that The view taken in the economic literature is that unions maximize an objective (utility) function subject to firm behaviour

Typically assume that a union’s utility depends on wages and employment – and that unions want more of both

• Note that the union’s objectives are not necessarily the same as those of the union members
• Asymmetric information on the available options may allow the union to pursue its own objectives
• Heterogeneity of preferences among union members may make it difficult to represent all members goals
• Nonetheless it is useful to think of the union acting as a single decision making unit in search of higher wages and employment

Thus, the union’s indifference curves have the usual shape

Downward Sloping:

• High wage is necessary to compensate for low employment

Convex:

• With a high wage and low employment willing to give up a lot of wages to increase E

• What really matters to workers is the real wage W/P

The worker’s alternative wage also matters

Represents lower bound on wage compensation

Otherwise would choose the alternative (especially when faced with union dues)

Union Constraints

• The “choice” of wages and employment by the union is constrained by the firm’s behaviour
• Assume that the firm is dealing with a profit maximizing competitive firm
• Also assume (initially) that the determination of wages and employment is carried out in two stages
• In the first stage the union and firm negotiate over the wage
• In the second stage the firm is allowed to choose the level of employment based on the negotiated wage
• The firm need only to look to its labour demand curve which specifies the profit maximizing employment level at each wage

In a sense, the firm’s labour demand curve can be viewed as a constraint on union behaviour

• If the firm can not be induced off of the demand curve
• Union utility maximization occurs at a point of tangency (a₀)

1. a₀ represents one of the possible outcomes from collective bargaining in this model
2. In fact, it is the unions preferred outcome

The Firm’s Preferred Outcome

The firm prefers outcomes that yield higher profits

Profits vary along the firm’s labour demand curve

• To see this consider the firm's isoprofit curves

• Each isoprofit is maximized at the demand curve

• The demand curve gives the profit-maximizing employment level at each wage e.g. given w* the firm maximizes profits at E*

1. Isoprofits lower on the demand curve are associated with higher profits (preferred by the firm)
2. For a given level of employment (E*) profits will be higher when wages are lower E*

Bargaining Range

The range of wages along the demand curve over which bargaining can occur is constrained

1. The lowest possible wage the firm can negotiate is W_a

- Thus, the firm’s ideal wage/ employment combination is If (where W_f =W_a)

2. The zero-profit isoprofit limits the wage the union can ask for

- Doesn’t want the firm to go out of business

As drawn the zero profit constraint is not binding

The union prefers a wage less than W₀ (I_U) because of the negative employment effects of a higher wage

The bargaining range is the interval [W_a,min(W₀,W_U)]