Question

How do modern labor unions affect workers and labor markets?

Answer 1

Labor unions are formed with the motive of seeking wages higher than the market clearing wage rate. Rudimentary knowledge in economics tells us that at equilibrium, demand equals supply. Let w* be the wage rate where demand equals supply and the labor market is in equilibrium. Unions demand a higher wage rate than w* (say w1). At this wage rate, demand for labor by the supplier falls to D1 and amount of labor supplied by workers rises to S1 thereby creating an excess supply in the labor market. Had this institutionally fixed wage rate not existed, excess supply would have caused wage rate to fall back to w* and the market would clear. However, this minimum fixed wage prevents markets from clearing and workers are laid off their jobs. The D1 workers who managed to remain employed earn a higher wage and enjoy a better life at the cost of (L*-D1) workers.

This creates unemployment in the labor market. Employment relief schemes have to be sought by the government for the (L*-D1) workers adding to the burden of the government.

(Diagram is drawn in the image attached.)