Question

A market in perfect competition is in long-run 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 due to labor unions will result in higher production costs for firms, leading to a higher market price in the short run. In the long run, the market adjusts as new firms enter the market, increasing competition and reducing prices, although not to the original equilibrium price due to the increased wages. A new long-run equilibrium is established with higher market prices and potentially different output levels, yet firms still earn zero economic profit.

Step-by-step solution

Understand Perfect Competition and Long-run Equilibrium

In a perfectly competitive market, there are numerous buyers and sellers in the market such that no individual participant can affect the market price. In the long-run equilibrium, firms earn zero economic profit. This means that the market price equals each firm's minimum average total cost. At this point, there is no incentive for new firms to enter the market because they cannot earn more than their costs, and existing firms will not exit the market, as they can cover their costs.

Analyze the Effect of Increased Wages

If labor unions are able to increase wages for workers, this will increase production costs for the firms in the industry because labor is a large input in production. Higher production costs will lead to a higher average total cost for each firm in the market.

Determine the New Short-run Equilibrium

With higher average total costs due to increased wages, firms will need to charge a higher price for their goods or services to cover their costs. In the short-run, this will result in a higher market price, and the firms will adjust their production levels accordingly. Some firms might temporarily be able to make a positive economic profit.

Analyze Firm Entry or Exit

In the long run, if some firms are earning positive economic profits due to the higher market price, then new firms will be attracted to enter the market, increasing the market supply. As more firms enter, the market price will decrease because of the increased competition. However, since wages are increased, the market price will not return to the original long-run equilibrium price.

Establish the New Long-run Equilibrium

The market will reach a new long-run equilibrium at the point where the average total cost (including the increased wage rates) equals the market price, resulting in zero economic profit for all firms in the market. The new equilibrium will have a higher market price and potentially a different market output level. To summarize, the increase in wages due to labor unions' actions will result in higher production costs for firms in a perfectly competitive market. This will lead to an increase in the market price and a new long-run equilibrium, where firms are back to earning zero economic profit. The new equilibrium will be characterized by a higher market price and potentially a different market output level.

Key concepts

Long-run Equilibrium

In a perfectly competitive market, the long-run equilibrium is an essential concept. It occurs when firms in the market earn zero economic profit. This means that the expenses of the firm, which include production costs, are exactly matched by the revenue it earns.
At this point, market price equals the average total cost of production, and firms are covering their costs without any additional profit.
This balance prevents firms from either entering or exiting the market, as they can't make more than what's needed to break-even.

• Firms earn just enough to cover costs and earn a normal rate of return.
• No incentives exist for new entrants or the exit of existing firms.
• Market supply meets market demand perfectly.

The equilibrium ensures that resources are allocated efficiently, and consumer prices reflect marginal production costs.

Labor Unions

Labor unions play a significant role in organizing workers to negotiate better wages and working conditions. Their bargaining power can shift costs within a market, particularly through wage negotiations.
When unions successfully secure higher wages, this change directly affects a company's cost structure. Labor is a critical production input, and increasing labor costs impact business financials significantly.

• Unions advocate for worker interests in wage negotiations.
• Higher wages can lead to increased consumer demand if employees have more disposable income.
• Companies may need to adjust operations to accommodate increased wage expenses.

Through these mechanisms, labor unions can influence market behaviors and results. Their activities can alter both short-term and long-term equilibria in an industry.

Wage Increase

A rise in wages is not always a straightforward matter from an economic perspective. It's critical to understand how this influx affects market dynamics.
When wages rise, production costs rise, too, since wages are a fundamental cost component for nearly all businesses.
Higher costs push firms to increase prices of their products to sustain profitability.

• Increased wages = higher production costs for firms.
• Prices of goods and services may rise in response to increased costs.
• Some businesses might struggle to maintain profitability when costs rise too fast.

The price adjustments after a wage increase can initially lead to inflationary pressures, impacting both firms and consumers.

Production Costs

Production costs in economics refer to the expenses incurred by a business in the manufacture of goods or services. These costs include raw materials, labor, equipment, and overheads.
In a perfect competition scenario, minimizing production costs is crucial since firms cannot influence market prices.
When labor costs increase due to unions pushing for wage hikes, firms face higher average total costs.

• Key components: materials, labor, and general overhead.
• Increased wages = increased total production costs.
• Firms may adjust other costs to maintain competitive pricing.

Handling higher production costs involves strategic decisions around pricing, output levels, and potentially seeking more efficient production methods.