Chapter 8: Problem 8

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

Expert verified

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.