303 Reading: Price Setters on the Supply Side

Price Setters on the Supply Side

Buyers are not the only agents capable of exercising market power in factor-pricing choices. Suppliers of factor services can exercise market power and act as price setters themselves in two ways. First, a supplier may be a monopoly or have a degree of monopoly power in the supply of a factor. In that case, economists analyze the firm’s choices as they would analyze those of any other imperfectly competitive firm. Second, individual suppliers of a factor of production may band together in an association to gain clout in the marketplace. Farmers, for example, often join forces to offset what they perceive as unfair market power on the part of buyers of their products. Workers may join together in a union in order to enhance their bargaining power with their employers. Each case is discussed below.

Monopoly Suppliers

A firm with monopoly power over a particular factor can be expected to behave like any other monopoly. It will choose its output where the marginal revenue and marginal cost curves intersect and charge a price taken from its demand curve. A monopoly supplier of a factor faces a demand curve that represents the MRP of the factor. This situation is illustrated in Figure 14.6. The firm will charge a price Pm equal to the MRP of the factor and sell Qm units of the factor.

Unions

A labor union is an organization of workers that negotiates with employers over wages and working conditions. A labor union seeks to change the balance of power between employers and workers by requiring employers to deal with workers collectively, rather than as individuals. Thus, negotiations between unions and firms are sometimes called collective bargaining.

The subject of labor unions can be controversial. Supporters of labor unions view them as the workers’ primary line of defense against efforts by profit-seeking firms to hold down wages. Critics of labor unions view them as having a tendency to grab as much as they can in the short term, even if it means injuring workers in the long run by driving firms into bankruptcy or by blocking the new technologies and production methods that lead to economic growth. We will start with some facts about union membership in the United States.

FACTS ABOUT UNION MEMBERSHIP AND PAY

According to the U.S. Bureau of Labor and Statistics, about 11.3% of all U.S. workers belong to unions. Following are some of the facts provided by the bureau for 2013:

• 12.0% of U.S. male workers belong to unions; 10.5% of female workers do
• 11.1% of white workers, 13.4 % of black workers, and 9.8 % of Hispanic workers belong to unions
• 12.5% of full-time workers and 6.0% of part-time workers are union members
• 4.2% of workers ages 16–24 belong to unions, as do 14% of workers ages 45-54
• Occupations in which relatively high percentages of workers belong to unions are the federal government (26.9% belong to a union), state government (31.3%), local government (41.7%); transportation and utilities (20.6%); natural resources, construction, and maintenance (16.3%); and production, transportation, and material moving (14.7%)
• Occupations that have relatively low percentages of unionized workers are agricultural workers (1.4%), financial services (1.1%), professional and business services (2.4%), leisure and hospitality (2.7%), and wholesale and retail trade (4.7%)

In summary, the percentage of workers belonging to a union is higher for men than women; higher for blacks than for whites or Hispanics; higher for the 45–64 age range; and higher among workers in government and manufacturing than workers in agriculture or service-oriented jobs. Table 15.2 lists the largest U.S. labor unions and their membership.

In terms of pay, benefits, and hiring, U.S. unions offer a good news/bad news story. The good news for unions and their members is that their members earn about 20% more than nonunion workers, even after adjusting for factors such as years of work experience and education level. The bad news for unions is that the share of U.S. workers who belong to a labor union has been steadily declining for 50 years, as shown in Figure 15.2. About one-quarter of all U.S. workers belonged to a union in the mid-1950s, but only 11.3% of U.S. workers are union members today. If you leave out workers employed by the government (which includes teachers in public schools), only 6.6% of the workers employed by private firms now work for a union.

A Brief History of Unions

Workers have united to try to better their lot at least since the Middle Ages, when the first professional guilds were formed in Europe. In the United States, “workingmen’s societies” sprang up in the late eighteenth century. These organizations were craft unions uniting skilled workers in the same trade in an attempt to increase wages, shorten working hours, and regulate working conditions for their members.

One goal unions consistently sought was a closed shop, where only union members can be hired—an arrangement that gives unions monopoly power in the supply of labor. A second objective was to gain greater political and economic strength by joining together associations of different crafts. Union goals went largely unfulfilled until the twentieth century, when the courts began to favor collective bargaining between workers and employers in disputes over wages and working conditions. Closed-shop arrangements are illegal in the United States today, but many states permit union shop arrangements, in which a firm is allowed to hire nonunion workers who are required to join the union within a specified period. About 20 states have right-to-work laws which prohibit union shop rules.

The development of the industrial union, a form of union that represents the employees of a particular industry, regardless of their craft, also aided the growth of the labor movement. The largest industrial union in the United States, the AFL-CIO, was formed in 1955, when unions accounted for just over 35% of the labor force. The AFL-CIO remains an important economic and political force, but union strength has fallen since its peak in the 1950s; today, less than 10% of workers in the private sector belong to unions. Quite dramatically, in 2005, three unions, representing about a third of the total membership, withdrew from the AFL-CIO. The break-away unions argued that they would be more successful working on their own to recruit new members. The impact of this break-up will not be known for several years.

Part of the reason for the failure of unions to represent a larger share of workers lies in the market forces that govern wages. As the marginal revenue product of workers has risen throughout the economy, their wages have increased as well—whether they belonged to a union or not. Impressive economy-wide wage gains over the last two centuries may be one reason why the attraction of unions has remained weak.

HIGHER WAGES FOR UNION WORKERS

Why might union workers receive higher pay? What are the limits on how much higher pay they can receive? To analyze these questions, let’s consider a situation where all firms in an industry must negotiate with a single union, and no firm is allowed to hire nonunion labor. If no labor union existed in this market, then equilibrium (E) in the labor market would occur at the intersection of the demand for labor (D) and the supply of labor (S) in Figure 15.3. The union can, however, threaten that, unless firms agree to the wages they demand, the workers will strike. As a result, the labor union manages to achieve, through negotiations with the firms, a union wage of Wu for its members, above what the equilibrium wage would otherwise have been.

This labor market situation resembles what a monopoly firm does in selling a product, but in this case a union is a monopoly selling labor to firms. At the higher union wage Wu, the firms in this industry will hire less labor than they would have hired in equilibrium. Moreover, an excess supply of workers want union jobs, but firms will not be hiring for such jobs.

From the union point of view, workers who receive higher wages are better off. However, notice that the quantity of workers (Qd) hired at the union wage Wu is smaller than the quantity Qe that would have been hired at the original equilibrium wage. A sensible union must recognize that when it pushes up the wage, it also reduces the incentive of firms to hire. This situation does not necessarily mean that union workers are fired. Instead, it may be that when union workers move on to other jobs or retire, they are not always replaced. Or perhaps when a firm expands production, it expands employment somewhat less with a higher union wage than it would have done with the lower equilibrium wage. Or perhaps a firm decides to purchase inputs from nonunion producers, rather than producing them with its own highly paid unionized workers. Or perhaps the firm moves or opens a new facility in a state or country where unions are less powerful.

From the firm’s point of view, the key question is whether the higher wage of union workers is matched by higher productivity. If so, then the firm can afford to pay the higher union wages and, indeed, the demand curve for “unionized” labor could actually shift to the right. This could reduce the job losses as the equilibrium employment level shifts to the right and the difference between the equilibrium and the union wages will have been reduced. If worker unionization does not increase productivity, then the higher union wage will cause lower profits or losses for the firm.

Union workers might have higher productivity than nonunion workers for a number of reasons. First, higher wages may elicit higher productivity. Second, union workers tend to stay longer at a given job, a trend that reduces the employer’s costs for training and hiring and results in workers with more years of experience. Many unions also offer job training and apprenticeship programs.

In addition, firms that are confronted with union demands for higher wages may choose production methods that involve more physical capital and less labor, resulting in increased labor productivity. Table 15.3 provides an example. Assume that a firm can produce a home exercise cycle with three different combinations of labor and manufacturing equipment. Say that labor is paid $16 an hour (including benefits) and the machines for manufacturing cost $200 each. Under these circumstances, the total cost of producing a home exercise cycle will be lowest if the firm adopts the plan of 50 hours of labor and one machine, as the table shows. Now, suppose that a union negotiates a wage of $20 an hour including benefits. In this case, it makes no difference to the firm whether it uses more hours of labor and fewer machines or less labor and more machines, though it might prefer to use more machines and to hire fewer union workers. (After all, machines never threaten to strike—but they do not buy the final product or service either.) In the final column of the table, the wage has risen to $24 an hour. In this case, the firm clearly has an incentive for using the plan that involves paying for fewer hours of labor and using three machines. If management responds to union demands for higher wages by investing more in machinery, then union workers can be more productive because they are working with more or better physical capital equipment than the typical nonunion worker. However, the firm will need to hire fewer workers.

In some cases, unions have discouraged the use of labor-saving physical capital equipment—out of the reasonable fear that new machinery will reduce the number of union jobs. For example, in 2002, the union representing longshoremen who unload ships and the firms that operate shipping companies and port facilities staged a work stoppage that shut down the ports on the western coast of the United States. A key issue in the dispute was the desire of the shipping companies and port operators to use handheld scanners for record-keeping and computer-operated cabs for loading and unloading ships—changes which the union opposed. President George W. Bush invoked the Labor Management Relations Act of 1947—commonly known as the Taft-Hartley Act—and asked a court to impose an 80-day “cooling-off period” in order to allow time for negotiations to proceed without the threat of a work stoppage. Federal mediators were called in, and the two sides agreed to a deal in November 2002. The ultimate agreement allowed the new technologies, but also kept wages, health, and pension benefits high for workers. In the past, presidential use of the Taft-Hartley Act sometimes has made labor negotiations more bitter and argumentative but, in this case, it seems to have smoothed the road to an agreement.

In other instances, unions have proved quite willing to adopt new technologies. In one prominent example, during the 1950s and 1960s, the United Mineworkers uniondemanded that mining companies install labor-saving machinery in the mines. The mineworkers’ union realized that over time, the new machines would reduce the number of jobs in the mines, but the union leaders also knew that the mine owners would have to pay higher wages if the workers became more productive, and mechanization was a necessary step toward greater productivity.

In fact, in some cases union workers may be more willing to accept new technology than nonunion workers, because the union workers believe that the union will negotiate to protect their jobs and wages, whereas nonunion workers may be more concerned that the new technology will replace their jobs. In addition, union workers, who typically have higher job market experience and training, are likely to suffer less and benefit more than non-union workers from the introduction of new technology. Overall, it is hard to make a definitive case that union workers as a group are always either more or less welcoming to new technology than are nonunion workers.

Higher Wages and Other Union Goals

Higher wages once dominated the list of union objectives, but more recent agreements have also focused on nonwage issues involving job security, health insurance, provision of child care, and job safety. Unions such as the United Auto Workers have negotiated contracts under which members who are laid off will continue to receive payments nearly equal to the wages they earned while on the job. They have also pushed hard for retirement pensions and for greater worker involvement in management decisions.

Union efforts to obtain higher wages have different effects on workers depending on the nature of the labor market. When unions confront an employer with monopsony power, their task is clear: they seek a wage closer to MRP than the employer is paying. If the labor market is a competitive one in which wages are determined by demand and supply, the union’s task is more difficult. Increasing the wage requires either increasing the demand for labor or reducing the supply. If the union merely achieves a higher wage in the absence of an increase in demand or a reduction in supply, then the higher wage will create a surplus of labor, or unemployment.

Increasing Demand

The demand for labor in a competitive market is found by summing the MRP curves of individual firms. Increasing demand thus requires increasing the marginal product of labor or raising the price of the good produced by labor.

One way that unions can increase the marginal product of their members is by encouraging investment in their human capital. Consequently, unions may pressure firms to implement training programs. Some unions conduct training efforts themselves.

Another way to increase the MRP of a factor is to reduce the use by firms of substitute factors. Unions generally represent skilled workers, and they are vigorous proponents of minimum wage laws that make unskilled workers more expensive. A higher minimum wage induces firms to substitute skilled for unskilled labor and thus increases the demand for the skilled workers unions represent.

Still another way to increase the MRP of labor is to increase the demand for the products labor produces. The form this union activity generally takes is in the promotion of “Made in the U.S.A.” goods. Unions have also promoted restrictive trade legislation aimed at reducing the supply of foreign goods and thus increasing the demand for domestic ones.

Reducing Labor Supply

Unions can restrict the supply of labor in two ways. First, they can seek to slow the growth of the labor force; unions from the earliest times have aggressively opposed immigration. Union support for Social Security also cut the labor supply by encouraging workers to retire early. Second, unions can promote policies that make it difficult for workers to enter a particular craft. Unions representing plumbers and electrical workers, for example, have restricted the number of people who can enter these crafts in some areas by requiring that workers belong to a union and then limiting the union’s membership.

Bilateral Monopoly

Suppose a union has negotiated a closed-shop arrangement (in a country where such arrangements are legal) with an employer that possesses monopsony power in its labor market. The union has a kind of monopoly in the supply of labor. A situation in which a monopsony buyer faces a monopoly seller is called bilateral monopoly. Wages in this model are indeterminate, with the actual wage falling somewhere between the pure monopoly and pure monopsony outcomes.

Figure 14.7 shows the same monopsony situation in a labor market that was shown in Figure 14.3. The employer will seek to pay a wage Wm for a quantity of labor Lm. The union will seek Wu, the highest wage the employer would be willing to pay for that quantity of labor. This wage is found on the MRP curve. The model of bilateral monopoly does not tell us the wage that will emerge. Whether the final wage will be closer to what the union seeks or closer to what the employer seeks will depend on the bargaining strength of the union and of the employer.

THE DECLINE IN U.S. UNION MEMBERSHIP

The proportion of U.S. workers belonging to unions has declined dramatically since the early 1950s. Economists have offered a number of possible explanations:

• The shift from manufacturing to service industries
• The force of globalization and increased competition from foreign producers
• A reduced desire for unions because of the workplace protection laws now in place
• U.S. legal environment that makes it relatively more difficult for unions to organize workers and expand their membership

Let’s discuss each of these four explanations in more detail.

A first possible explanation for the decline in the share of U.S. workers belonging to unions involves the patterns of job growth in the manufacturing and service sectors of the economy shown in Figure 15.4. The U.S. economy had about 15 million manufacturing jobs in 1960. This total rose to 19 million by the late 1970s and then declined to 17 million in 2013. Meanwhile, the number of jobs in service industries and in government combined rose from 35 million in 1960 to over 118 million by 2013, according to the Bureau of Labor Statistics. Because over time unions were stronger in manufacturing than in service industries, the growth in jobs was not happening where the unions were. It is interesting to note that several of the biggest unions in the country are made up of government workers, including the American Federation of State,County and Municipal Employees (AFSCME); the Service Employees International Union; and the National Education Association. The membership of each of these unions is listed in Table 15.2. Outside of government employees, however, unions have not had great success in organizing the service sector.

A second explanation for the decline in the share of unionized workers looks at import competition. Starting in the 1960s, U.S. carmakers and steelmakers faced increasing competition from Japanese and European manufacturers. As sales of imported cars and steel rose, the number of jobs in U.S. auto manufacturing fell. This industry is heavily unionized. Not surprisingly, membership in the United Auto Workers, which was 975,000 in 1985, had fallen to roughly 390,000 by 2013. Import competition not only decreases the employment in sectors where unions were once strong, but also decreases the bargaining power of unions in those sectors. However, as we have seen, unions that organize public-sector workers, who are not threatened by import competition, have continued to see growth.

A third possible reason for the decline in the number of union workers is that citizens often call on their elected representatives to pass laws concerning work conditions, overtime, parental leave, regulation of pensions, and other issues. Unions offered strong political support for these laws aimed at protecting workers but, in an ironic twist, the passage of those laws then made many workers feel less need for unions.

These first three possible reasons for the decline of unions are all somewhat plausible, but they have a common problem. Most other developed economies have experienced similar economic and political trends, such as the shift from manufacturing to services, globalization, and increasing government social benefits and regulation of the workplace. Clearly there are cultural differences between countries as to their acceptance of unions in the workplace. The share of the population belonging to unions in other countries is very high compared with the share in the United States. Table 15.4 shows the proportion of workers in a number of the world’s high-income economies who belong to unions. The United States is near the bottom, along with France and Spain. The last column shows union coverage, defined as including those workers whose wages are determined by a union negotiation even if the workers do not officially belong to the union. In the United States, union membership is almost identical to union coverage. However, in many countries, the wages of many workers who do not officially belong to a union are still determined by collective bargaining between unions and firms.

These international differences in union membership suggest a fourth reason for the decline of union membership in the United States: perhaps U.S. laws are less friendly to the formation of unions than such laws in other countries. The close connection between union membership and a friendly legal environment is apparent in the history of U.S. unions. The great rise in union membership in the 1930s followed the passage of the National Labor-Management Relations Act of 1935, which specified that workers had a right to organize unions and that management had to give them a fair chance to do so. The U.S. government strongly encouraged the formation of unions during the early 1940s in the belief that unions would help to coordinate the all-out production efforts needed during World War II. However, after World War II came the passage of the Taft-Hartley Act of 1947, which gave states the power to allow workers to opt out of the union in their workplace if they so desired. This law made the legal climate less encouraging to those seeking to form unions, and union membership levels soon started declining.

The procedures for forming a union differ substantially from country to country. For example, the procedures in the United States and those in Canada are strikingly different. When a group of workers wish to form a union in the United States, they announce this fact and an election date is set when the employees at a firm will vote in a secret ballot on whether to form a union. Supporters of the union lobby for a “yes” vote, and the management of the firm lobbies for a “no” vote—often even hiring outside consultants for assistance in swaying workers to vote “no.” In Canada, by contrast, a union is formed when a sufficient proportion of workers (usually about 60%) sign an official card saying that they want a union. There is no separate “election date.” The management of Canadian firms is limited by law in its ability to lobby against the union. In addition, though it is illegal to discriminate and fire workers based on their union activity in the United States, the penalties are slight, making this a not so costly way of deterring union activity. In short, forming unions is easier in Canada—and in many other countries—than in the United States.

In summary, union membership in the United States is lower than in many other high-income countries, a difference that may be due to different legal environments and cultural attitudes toward unions.

Unions and the Economy: An Assessment

Where unions operate effectively in otherwise competitive markets, they may reduce economic efficiency. Efforts to increase demand for American workers through restricting imports or to increase demand for skilled workers by restricting opportunities for unskilled workers almost certainly reduce economic efficiency. Artificial restrictions on the supply of labor reduce efficiency as well. In each case, the wage gain will increase the cost of producing a good or service and thus shift its supply curve to the left. Such efforts, if successful, increase the earnings of union members by creating higher prices and smaller quantities for consumers. They may also reduce the profitability of their employers.

Other attempts by unions to raise wages by increasing the demand for their members are not likely to create inefficiency. For example, union efforts to increase worker productivity or to encourage consumers to buy products made by union members do not reduce economic efficiency.

In the case of bilateral monopoly, the amount of labor employed is restricted by the monopsony firm to a quantity that falls short of the efficient level. In effect, the efficiency damage has already been done. The labor union seeks merely to offset the monopsony firm’s ability to restrict the wage.

Are unions successful in their primary goal of increasing wages? An examination of the impact on wages paid by firms that faced organizing drives by unions between 1984 and 1999 found virtually no change in wages attributable to union organizing efforts. The study examined firms in which unions had either barely won or had barely lost the election. It found that unions that had eked out victories had gone on to organize workers but had had no significant impact on wages or on productivity. Other evidence, however, suggests that unions do tend to raise wages for their members. Controlling for other factors that affect wages, over the period 1973 to 2002, unions appear to have increased wages by about 17% on average. Part of the explanation of this finding is that unions have had the most success in organizing in the public sector, where union pressure for higher wages is most likely to be successful.

Other Suppliers and Monopoly Power

Just as workers can unionize to gain a degree of monopoly power in the marketplace, so other suppliers can organize with a similar goal. Two of the most important types of organizations aimed at garnering market power are professional associations and producers’ cooperatives.

Professional Associations

Professional people generally belong to organizations that represent their interests. For example, physicians in the United States belong to the American Medical Association (AMA), and lawyers belong to the American Bar Association (ABA). Both organizations work vigorously to advance the economic interests of their members.

Professional organizations often lobby for legislation that protects their members. They may seek to restrict competition by limiting the number of individuals who can be licensed to practice a particular profession. The AMA has been very successful in limiting the number of physicians, thus maintaining higher salaries than would otherwise exist. The ABA has fought legal reforms aimed at limiting awards to plaintiffs who win damage suits; such reforms would be likely to reduce the incomes of lawyers.

Producers’ Cooperatives

Independent producers sometimes band together into a cooperative for the purpose of selling their products. The cooperative sets the price and assigns production quotas to individual firms. In effect, a cooperative acts as a legal cartel.

Because they violate the provisions of laws that outlaw such arrangements in most industries, producers’ cooperatives must be authorized by Congress. Farmers have sometimes been given such rights when they are confronted by monopsony buyers. For example, Congress granted dairy farmers the right to form cooperatives in the 1920s because they faced monopsony buyers. High transportation costs for fresh milk, together with economies of scale in processing milk, generally left only one dairy processor to buy raw milk from dairy farmers in a particular area. By forming a cooperative, farmers could counter the monopsony power of a processor with monopoly power of their own, creating a bilateral monopoly.

Today, with much lower transportation costs, dairy farmers can deal with a national market so that processors no longer have monopsony power. But dairy farmers continue to have the right to form cooperatives. As we have seen in an earlier module, dairy farmers also enjoy protection from federal programs that are designed to keep dairy prices high.

Case in Point: Unions and the Airline Industry

Unions represent 60% of the non-managerial employees of U.S. airlines. And labor costs make up one-third of airline costs. All employees have a stake in the success of the firms for which they work. That is certainly the case for the major unions representing airline employees. Both union leaders and airline management have much to gain from a relationship that benefits both employees and the airlines that employ them.

That sort of relationship has not always existed. In 1981, for example, Continental Airlines hired Frank Lorenzo, an airline entrepreneur, to run Continental. The airline had lost money the previous three years. Mr. Lorenzo promptly abrogated Continental’s contracts with employees, and told them that they could go back to work but only at sharply reduced wages. Continental’s pilots, flight attendants, and ground crews declared strikes against the airline. The airline was able to break the strike by hiring replacement employees. Even so, Continental declared bankruptcy in 1983. Mr. Lorenzo told striking employees that they could return to work, but they could do so only by agreeing to work at half their previous wage. Continental’s strategy of union suppression achieved reductions in wage costs, but those savings had a cost as well. A demoralized labor force produced dramatic reductions in the quality of service, and Continental was back in bankruptcy in 1991. In 1986, 6,000 members of the International Federation of Flight Attendants (IFFA) declared a strike against TWA. The airline followed a strategy similar to Continental’s and was able to break the strike by hiring replacement employees. After 10 weeks, the IFFA declared an unconditional end to the strike and sought to have its members rehired. It was not until three and a half years later that all 6,000 got their jobs back. Ultimately, TWA went out of business.

Not all airlines have had the same unhappy relationships with unions. Southwest Airlines, which started as a nonunion airline, now operates with a largely unionized labor force. It has continued its strategy of paying high wages and including employees in management decisions. The result has been one of the highest profit margins in the industry together with high productivity of both workers and aircraft.

Continental has also emerged as a “different” airline. More recently, it hired a new Chief Executive Officer who quickly returned the airline to profitability and established a new workplace culture in which employees were given a role in managerial decisions and were hired based in part on their teamwork skills. Continental has been able to shed its old reputation as a union suppressor and has established itself as an airline that works well with unions and has a minimal degree of conflict.

Another approach to dealing with airline employees has been to include them in ownership. United employees, for example, own the airline. Other airlines in which employees have had a substantial ownership role include Western Airlines, Eastern Airlines, Northwest, Delta Airlines, and United. In each case, employees exchanged equity for wage concessions. Each of these airlines implemented an Employee Stock Ownership Plan (ESOP). In each case, the program began with great optimism on the part of management and labor, but in most cases, conflicts between workers and their employers quickly emerged. Western and Eastern abandoned their ESOP programs after two years. While nearly all of the ESOP arrangements initially increased profits, none of them was accompanied by any structural change in the labor-management relationship. Ultimately, all of these plans generated disappointing results. Clearly, the mere creation of a system in which employees own a share of the airline is not sufficient; changes in the structure of the labor-management relations must occur as well. Some airlines have managed to prosper in a difficult economic world. The key to success seems to lie in the establishment of workplace culture that rewards good teamwork and efforts to enhance productivity. Airlines such as Southwest and the “new” Continental demonstrate that an airline can work effectively with unions, pay high wages, and still be profitable.