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Government Intervention

Unemployment Benefits

Unemployment benefits have an important influence on labour supply, especially for low income workers. If unemployment benefit is provided at too high a level then workers may opt to live on unemployment benefits rather than take up low-skilled (and low-paid) employment.  A reduction in unemployment benefits may induce an increase in labour supply. However such a policy needs to be balanced against the need to provide a safety net for those who are unable to find work.

Incentive Effects

There are dangers in making the taxation system to progressive. Most people agree that income tax should be relatively progressive (those who are on higher incomes should pay a higher rate of tax than those on lower income as a form of redistributing incomes within a society and preventing inequality from extremes). However there comes a point where the tax rates are so high that a large proportion of additional is taxed away, reducing the incentives for individuals to supply additional effort or labour. This may result in a shift from highly skilled, highly paid jobs.

Minimum Wage

The market for labour shows an example of government intervention in the form of minimum prices. This is known as the national minimum wage (NMW) were every worker has to be paid a certain wage. The effect of this is shown on the graph to the left. 

Firms want to buy Q1 units of labour at the minimum wage, whereas workers want to supply Q2 units of labour at the minimum wage, this causes excess supply (unemployment).

If the NMW was to be lowered then there would be an increase in the quantity of labour demanded but at a lower wage. 

We can see that there is a lower excess in supply as the NMW is reduced.

Trade Unions

Trade unions are associations of workers that negotiate with employers on the pay and working conditions of members of the union. Trade unions have 3 major objectives; wage bargaining, improvement of working conditions and the security and health of their members.

There are 2 ways in which a trade union may seek to affect labour market equilibrium. It may limit the supply of workers into an occupation or industry (you may legally have to be a member of a certain union to enter a profession). Also it may negotiate for higher wages for its members. 

Restricting Labour Supply

The graph to the left is a normal labour graph for a firm. However if the firm is facing a trade union that limits the amount of labour into the market then the unions will be able to artificially push the wage up. 

In this situation the union is effectively trading off higher wages for its members, against a lower level of employment. The people that aren’t a member of the union, but would be happy to supply their labour at w*, can’t (as they are not a member of the compulsory union) and so remain unemployed, imposing a cost on society.

The extent of the trade off depends on the elasticity of demand for labour. When demand for labour is more elastic the wage increase is lower, whereas with inelastic demand for labour the wages rises more than that of elastic demand for labour.

Negotiating Wages

Alternatively a trade union can attempt to negotiate higher wages for its members. If they succeed then the wage will be higher but the level of unemployment will be also higher as the firm hires less labour.

Again the elasticity of demand for labour affects the outcome, when demand is more inelastic the effect on the quantity of labour employed is less than when demand is more elastic. This means that when demand for labour is inelastic unemployment will be lower (than when demand for labour is elastic). This is shown in the graph below. We is the natural equilibrium for labour, however the trade union has negotiated the waged to W*, at DL1 (inelastic demand for labour) there is less unemployment that at DL2 where unemployment is higher.

Job Security

Workers will have more job security if they are a member of a union as the union will take legal action. From a firms point of view this can lead to an increase in motivation as workers feel secure and this leads to an increase in productivity.

Labour Market Flexibility

Unions have affected the degree of flexibility of the labour market; their actions limit the entry of workers into a market.

Page last updated on 20/10/13