Labour Markets and Wage Determination: Question 5

Worked solution

Part (a): Transfer earnings, economic rent, and the pilot/checkout-assistant wage gap

Transfer earnings are the minimum payment a worker must receive to keep them supplying their labour in its current use; they are equal to what that worker could earn in their next-best alternative occupation. Economic rent is any payment a worker receives above transfer earnings. A surplus that is not needed to keep them in their current job, but which the market nonetheless allows them to earn. A worker’s total wage is therefore the sum of transfer earnings and economic rent.

The split between these two depends on the wage elasticity of labour supply to the occupation:

• Piloting requires years of expensive flight training, medical certification, and access to a limited number of training-school and simulator places. Because of this, the number of people who can become qualified pilots cannot expand quickly even if the wage on offer rises a great deal. The supply of pilots is highly wage-inelastic (a steep supply curve). With such an inelastic supply, existing pilots have few equally well-paid alternative uses for their specific skills, so most of what they are paid is not needed to keep them from leaving the occupation: a large share of a pilot’s wage is economic rent.
• Checkout-assistant jobs require little specific training, and there are many similar, similarly-paid jobs available in retail and hospitality that a checkout assistant could move into instead. This makes the supply of checkout assistants highly wage-elastic (a flat supply curve). Because workers could readily earn almost the same wage elsewhere, nearly the whole wage is needed simply to keep them from leaving for that next-best alternative: almost all of a checkout assistant’s wage is transfer earnings, leaving little economic rent.

This difference in the elasticity of labour supply, driven by how easy or difficult it is to enter each occupation, is exactly why pilots and checkout assistants receive very different wages even though both are, in a sense, “workers”: the wage differential reflects labour market forces operating very differently on the supply side of each occupation.

Part (b): Discussing the effect of a higher minimum wage on checkout-assistant employment

The case for a fall in employment. If the labour market for checkout assistants in Solandra is genuinely competitive (plausible, since many competing supermarket chains and other retailers all hire similar workers) then raising the minimum wage above the current equilibrium wage should, other things equal, reduce the quantity of labour demanded: employers move up along their (downward-sloping) demand curve for checkout-assistant labour as it becomes more expensive to employ them, while the quantity of labour supplied rises as the higher wage attracts more people into the occupation. The resulting gap between quantity supplied and quantity demanded appears as unemployment among would-be checkout assistants. The size of the fall in employment depends on the wage elasticity of demand for this labour: if demand is relatively elastic (for example because supermarkets can substitute towards self-service checkouts and other automation, or because demand for the supermarket’s own output is itself price-elastic so that a higher wage bill quickly threatens jobs) then even a moderate minimum-wage rise could cause a substantial fall in employment. If demand is more inelastic, for example if there are few practical substitutes for checkout staff in the short run, the same wage rise would cause a much smaller fall in employment.

The case against a fall in employment. This standard prediction assumes a competitive labour market, but if at least some large supermarket chains hold monopsony power over checkout-assistant labour in particular local markets (for instance, a town with only one significant supermarket employer) the outcome can be very different. A monopsony employer already pays a wage, and hires a level of employment, below what a competitive market would produce, because its marginal cost of labour exceeds the wage rate it pays (as established where the employer must raise the pay of all existing workers to attract an extra one). Introducing a minimum wage set somewhere between the monopsony wage and the fully competitive wage removes part of the monopsonist’s incentive to restrict hiring purely to avoid raising pay for its whole existing workforce. Over this range, a minimum wage can actually raise both the wage and the level of employment together, rather than reducing jobs. Only if the minimum wage were pushed above the fully competitive wage would employment then start to fall, much as in the competitive case.

Reaching a judgement. Because checkout-assistant jobs are offered by many competing retailers across Solandra as a whole, the national market is plausibly closer to competitive on average, which would suggest that a substantial rise in the minimum wage is, on balance, likely to reduce employment somewhat. However, this conclusion is far from certain: it depends heavily on how wage-elastic the demand for checkout-assistant labour actually turns out to be, and any local monopsony power, most likely in smaller towns with few alternative employers, would reduce, or could even reverse, the predicted job losses in those areas. The employment effect of a higher national minimum wage is therefore conditional on market structure and elasticities, rather than an automatic or uniform outcome across Solandra.

Final answers

• (a) Transfer earnings = minimum payment needed to retain a worker in their current use; economic rent = payment above this. Pilots have wage-inelastic supply (high entry barriers) so most of their wage is economic rent; checkout assistants have wage-elastic supply (easy entry) so most of their wage is transfer earnings
• (b) The employment effect of a higher minimum wage depends on the elasticity of demand for checkout-assistant labour and on whether the market is competitive or monopsonistic. Likely job losses in a competitive market (more so if demand is elastic), but a possible rise in both wage and employment where monopsony power exists, so the overall effect is conditional, not automatic