Question

Explain what the spillover effect and the threat effect are in a two-sector framework. Include their diagrams.

Answer 1

the two sector framework being union and non union labor market where the phase of unionization creates a demand for skilled workers and cost is incurred on monitoring and supervision of workers. It also has an impact on the wages in the non union labor market, upwards or downward bias affecting the wage advantage in the union labor market which is measured by the amount by which union wage is greater than non union wages.

The following effects show how union wage setting has an impact on the non union wage and how ultimately it affects union workers.

(i) spillover effect : when union workers are displaced and they supply their labor to non union labor market leads to lower wages in the non union market. A hike in union wages has a spillover effect on non union wages and seems to over emphasis the wage advantage in unionized markets.

(ii) threat effect : an increment in the wages of non unionized market by collective bargaining or threat to unionization imposed on the employer. hence, this effect would increase wages in the non union labor market.

the graph which depicts the two effect as a response in the non union labor market is shown as below: