Question

A market in perfect competition is in long-nun equilibrium. What happens to the market if labor unions are able to increase wages for workers?

Short answer

In a perfectly competitive market in long-run equilibrium, an increase in wages for workers will cause an increase in production costs, leading to higher marginal costs for firms. In the short run, this will result in a higher market price and lower equilibrium quantity. In the long run, some firms will exit the market due to economic losses, leading to a higher market price, lower equilibrium quantity, and a smaller number of firms in the industry than before the wage increase.

Step-by-step solution

1. Understanding a Perfect Competition Market in Long-run Equilibrium

In a perfectly competitive market, there are many firms, each producing a homogenous product. Firms in perfect competition are price takers, meaning they have no ability to control the market price. They can only decide the quantity of output to produce based on market forces. A market is in long-run equilibrium when firms can neither enter nor exit the market, and economic profits are zero. At this point, the market price has adjusted to the level where all firms in the industry are earning normal profits, and there are no incentives for firms to enter or leave the market. The long-run supply curve in perfect competition is horizontal, reflecting this zero-profit equilibrium condition.

2. Analyzing the Impact of Increased Wages

If labor unions successfully negotiate an increase in wages for workers, the cost of production for firms within the market will rise. In the short run, the existing firms have to continue producing at the higher cost due to the fixed number of firms in the market, and the fixed amount of capital.

3. Short-run Impact on Market Supply and Equilibrium

When the cost of production for firms increases due to higher wages, their marginal costs also increase. Firms will supply less output at each price level, shifting the industry short-run supply curve to the left. This will result in a higher market price and a lower equilibrium quantity in the short run.

4. Long-run Adjustments and New Equilibrium

In the long run, firms can adjust their input levels to minimize costs and maximize profits. Given the higher wage rates, the cost structure for all firms in the industry has changed. As a result, the average cost curve for each firm will shift upward. Since economic profits were zero in the initial long-run equilibrium, the higher costs will translate into economic losses for some firms, causing them to exit the market. As these firms exit, the industry's supply curve will shift further to the left, and market prices will continue to rise until the remaining firms once again earn zero economic profits. The new long-run equilibrium will result in a smaller number of firms in the industry, a higher market price, and a lower equilibrium quantity than before the wage increase. In conclusion, an increase in wages for workers in a perfectly competitive market that is in long-run equilibrium will lead to an increase in the costs of production, resulting in higher market prices and lower equilibrium quantity in the long run. This will also cause some firms to exit the market, making the industry smaller than it was before the wage increase.