To each according to his contribution. Do state interventions always have a negative impact on the labor market?

Term Paper (Advanced seminar), 2014

45 Pages, Grade: 2,0


Table of Content

Table of Figures

Table of Charts

1 Introduction

2 How does the labor market behave?
2.1 The labor market from a neo-classical perspective
2.2 The individual supply of work
2.3 Criticism of the neo-classical model according to Steve Keen

3 Unemployment Insurance
3.1 The effects of implementing an UI from a neo-classical perspective
3.2 Review of the neo-classical assumptions concerning UI systems
3.3 Scientific points of view

4 Minimum Wages
4.1 Definiton minimum wage
4.2 Minimum wages from a neo-classical perspective
4.3 Arguments in favor of a minimum wage:
4.4 Arguments against a minimum wage:
4.5 Scientific points of view:

5 Trade Unions
5.1 Comparison of the liberal and coordinated market economy
5.2 Comparison of the German and American institutional framework
5.3 Trade Unions in Germany
5.4 Trade Unions in the US

6 Incentive Wages
6.1 USA
6.2 Germany
6.3 Germany vs. USA
6.4 Do interventions have a negative impact?

7 Conclusion


Table of Figures

Figure 1 Neoclassical Labor Graph

Figure 2 Shift of demand in labor

Figure 3 Movement along the Supply in the Labor Market

Figure 4 The individual’s income-leisure trade-off

Figure 5 Nationwide Minimum Wages referring to the ‘WSI-Mindestlohndatenbank’

Figure 6 Introducing a Minimum Wage

Figure 7 Employment protection and stock market capitalization

Figure 8 Trade Union Membership in Germany

Table of Charts

Chart 1: CEO salaries in the US

Chart 2: Salaries of German chief executives

1 Introduction

In common theory labor is often treated like a normal commodity. This point of view is represented by neo-classical economists. Resulting in their general statement that markets – including the labor market – are driven only by supply and demand thus regulating themselves. Hence there is no space for any external interventions which due to the neo-classical opinion always have a negative effect. This provoking statement leads to the question whether this scenario can be observed in real world.

Based on the book Debunking Economics by Steve Keen the following research paper wants to provide a differentiated view concerning labor and how it can be treated in the economy. The first part of the dissemination paper reviews the neo-classical perspectives on the labor market followed by a reproduction of Keen’s critical review concerning the neo-classical theory and his own elaboration of the labor market.

The principle part concentrates on the treatment of labor force in the labor market and the possible outcome of several policies such as introducing or altering minimum wages, unemployment insurance (UI) and trade unions. Regarding to the research question whether an impact of the government has positive or negative impact on the labor market, the aim is to establish a link between labor market regulations, economic policies and theory. In this context the analysis shows what theory suggests and which outcomes can be observed by implementing regulations derived from theory.

Finally the paper sums up the most important results and points out unanswered aspects which could be further discussed and analyzed to evaluate the impacts of external interventions on the labor market more precisely.

2 How does the labor market behave?

2.1 The labor market from a neo-classical perspective

Before we start describing the labor market from a neo-classical perspective to simplify the model, we need to assume:

(1) Perfect competition
(2) Perfect information
(3) Mobile labor.

Neo-classical economists assume under these conditions, that the supply curve is upward-sloping and the demand curve is downward-sloping. Whereby the x-axis is defined as ‘labor’ (L) and the y-axis is defined as ‘wage’ (W). The wage is determined by contribution to production, meaning the higher the wage a worker gets paid, the higher the marginal productivity of the employee for the firm. In consequence, the firm hires workers up to the point where marginal costs equal marginal revenue of the last worker hired.

illustration not visible in this excerpt

Figure 1 Neoclassical Labor Graph

Therefore, as shown in Figure 1, the wage is set by the intersection of aggregate demand and aggregate supply. Whereas the aggregate demand is the sum of all individual firms and the aggregate supply is the sum of all individual workers.

To make the mechanism of the neo-classical model clearer, we describe two scenarios.

First we assume a manufacturing firm and an increased demand for its products. As a result the firm will try to increase its output and therefore the firm needs more productivity and in consequence more labor. This fact leads to a shift of the aggregate demand curve for labor to the right (Figure 2).

illustration not visible in this excerpt

Figure 2 Shift of demand in labor

In the second scenario we alter the wage of the workers. We assume that wages go up, which will result in an upward movement along the supply curve. In other words there are more workers willing to offer their labor for a higher wage, which does not imply that there will be more jobs offered by the firms.

illustration not visible in this excerpt

Figure 3 Movement along the Supply in the Labor Market

The mechanism of the model, described by the diagrams and the underlying assumptions lead to the major statement of neo-classical economists: Everything is decided by the power of the market! There is no room for any external interventions!

This model leads to the great debate, whether the labor market can be treated in the same manner as markets for any other commodity?!

2.2 The individual supply of work

In the book ‘Debunking Economics’ the author Steve Keen makes it quite clear that from his point of view, labor is something extraordinary. Whereas, in a market for regular goods the consumer demands commodities and the firms supply those. In the real world, there is no market for labor meaning there is no firm producing workers. As a result, the roles of the market participants switch and the consumer becomes the supplier. Meaning the workers supply labor and the firms ‘consume’ labor. This implies that wages do not reflect the workers contribution to production (marginal productivity). It is rather that each worker has his individual preference to balance hours of work and leisure time. Since work is in general seen as a burden for the worker, the wage provided for each hour worked must be high enough, so that the worker is willing to substitute leisure time for working time. These trade-offs are displayed in indifference curves and the hourly wage is represented by the budget line. Keen assumes that “the higher the wage, the steeper the budget line”. (Keen, S., 2013, p. 132) has to be. This implies that the potential income has to be on the y-axis and the leisure time on the x-axis. Since a day is restricted to 24 hours, the budget line is fixed at that point on the x-axis and ends at one point on the y-axis where the potential income is shown.

illustration not visible in this excerpt

Figure 4 The individual’s income-leisure trade-off

Source: Keen (2001)

The diagram shows that the worker with a higher hourly wage (worker A) will have more potential leisure time, than a worker with a lower hourly wage (worker B) at the same potential income level. This can be explained by the degree of the budget lines' slope. Therefore worker “A” reaches the same level of potential income much quicker than worker B and as a result needs to spend less hours of work and has more time to his disposal.

This clearly leads to the assumption, that every individual supply curve needs to be downward-sloping.

The labor market in that sense does not react as expected and observed in markets for any other commodity. According to neo-classic theory higher wages would imply a higher supply of labor. But as already described above, the individual supply curve of labor is downward-sloping, saying that higher wages imply less supply of labor.

Economists tend to solve such a phenomenon with the substitution and income effect. In this particular case of the labor market, the substitution effect will not apply, because a day has only 24 hours and working hours can just be substituted with leisure time to a certain extend.

2.3 Criticism of the neo-classical model according to Steve Keen

As mentioned before, in the neo-classical model labor is compared with any other commodity, but there are several arguments against this assumption. The focus of Keen's criticism lies on the shape of the individual supply curve, which we will pick up on in this chapter. Although Keen points out several issues in his book, we will concentrate on the aspects concerning external interventions, since this goes along with our research topic.

Supply curves

First of all, one has to take the peculiar characteristics of the labor market into account, which will be essential for the following argumentation: In contrast to regular goods, labor cannot be consumed but is rather rented by firms, in order to produce products for consumption. Therefore the roles of participants in the labor market turn out to be the other way round; the firm becomes the ‘consumer’ and the worker is the ‘supplier’.

As already explained above (2.2), each individual worker has different preferences regarding working hours and leisure time. Therefore the individual supply curve of each worker is always sloping downwards. In contrast to the aggregate upward-sloping supply curve of the neo-classical model, the derived aggregate supply curve of labor could therefore have any shape, also downward sloping. Taking the downward sloping aggregate demand curve of the neo-classical model for granted, there could be more than one intersection of both curves, meaning more than one equilibrium wage rate of which each one could be valid.

Leisure time

When accepting the neo-classical flow of the aggregate supply curve, another problem occurs. In the neo-classical model the aggregate supply curve of labor slopes upward. Therefore a decrease in wage implies also a decrease in the supply of labor. Accordingly, as the supply of labor decreases, the individual leisure time increases but with less income at workers disposal. Since leisure activities in general cost money, the additional leisure time cannot be used reasonably. For the majority of workers, in reality, work is not an option but an essential mean to survive and avoid poverty. As a result, a worker cannot randomly trade work and leisure time.

Trade Unions

The neo-classical model does not accept any external interventions by industrial or governmental institutions and further assumes perfect competition[1]. Since there is no empirical evidence in economic literature for a condition such as perfect competition, we assume an imperfect competitive environment. Besides the hypothesis that wages are determined by the marginal productivity, (neo-classical mind set) needs to be extended by the relative bargaining power of the workers on the one hand and the firms on the other. Taking the relative bargaining power and the fact of imperfect competition into account, one comes to the conclusion that there exists a wage span with a minimum and maximum limit. The bottom line is set by the firms, where marginal revenue product is the product of marginal revenue and marginal productivity. In this case workers are exploited, because the wage is lower than their contribution to the firms' revenue. Workers are completely dependent on the market mechanism and will not get, if they face powerful firms, fair wages. In order to avoid this circumstance, labor unions were formed to raise workers’ bargaining power and act as a single seller of labor. This implies that the value of each individual worker rises, the less labor is available for the Unions to sell to the firms. In the end the wage will be determined, by the relative bargaining power of both parties and will be located somewhere in between both limits. The existence of Trade Unions supports competition in the labor market and does not only have a negative impact.[2]

Redistribution of the state

Neo-classical economists in general are opponents of the redistribution of income by the state and they assume that social welfare can only be maximized by the market itself. The market economy from the neo-classical point of view, creates winners and losers in a so-called zero sum game. In order to create higher social welfare for all, income needs to be redistributed by a higher authority – “a benevolent central authority”.(Keen, S., 2013, p. 138)

According to their general statement of no intervention, this claim is a contradiction.

3 Unemployment Insurance

3.1 The effects of implementing an UI from a neo-classical perspective

The general assumption of neo-classical economists, is that UI causes unemployment.

To make this statement clearer, the following abstract explains the effects in accordance to reflections of Ehrenberg. He assumes, that UI is a fixed amount per employed worker and perfect competition. This scenario is displayed in Figure 5. In a system without UI, the equilibrium wage and employment level is described by the intersection point of labor supply and demand in ‘a’.

illustration not visible in this excerpt

Figure 5 Who bears the burden of a payroll tax?

Source: Ehrenberg, G.R. (2000)

In order to demonstrate the effects of introducing an UI on wages and level of employment, two scenarios are considered.

In the first scenario, the costs of UI are completely transferred to the workers. Meaning that only the wage decreases exactly by the amount of the price, each individual worker has to contribute to UI. Employers do not have to cover any of the costs and thus the level of employment remains the same.


[1] Perfect competition refers to the labor market as well as to the product market.

[2] We will explain this statement in Chapter 5

Excerpt out of 45 pages


To each according to his contribution. Do state interventions always have a negative impact on the labor market?
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ISBN (Book)
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labor, neo-classical theory, Steve Keen, labor market
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M. Sc. Bahadir Düsendi (Author)Ali Salman (Author)Dominik Norbert Nösner (Author)Stephanie Knauer (Author)Sari Fawzi Mohamed Shokr (Author)Rui Yang (Author), 2014, To each according to his contribution. Do state interventions always have a negative impact on the labor market?, Munich, GRIN Verlag,


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