Equality and Inequality Under Perfect Competition
The mythical world of perfect wage equality
Under certain very strict assumptions, a perfectly competitive market will lead to perfect equality of wage rates. All workers will earn exactly the same. These strict assumptions are as follows:
All workers have identical abilities.
There is perfect mobility of labor.
All jobs are equally attractive to all workers.
All workers and employers have perfect knowledge.
Wages are determined entirely by demand and supply.
Given these assumptions, if consumer demand rose in any industry, the demand for labor would rise. As a result, wage rates would begin to rise. Immediately workers would flood into this industry, attracted by the higher wages. Very quickly, then, wage rates would be competed back down to the level in the rest of the economy. Likewise if wage rates began to fall in any industry, workers would leave, thereby eliminating any labor surplus and preventing the fall in wage rates. Under these conditions, therefore, not only would the labor supply curve to a firm be infinitely elastic, but so too would the labor supply curve to each industry at the universal wage rate. Of course, in the real world these conditions do not hold. Huge inequalities of wages exist. A financial dealer in the City can earn fifty times as much as a shop assistant. But even if markets were perfect, inequality would be expected to persist.
Causes of inequality under perfect competition
In the short run, inequality will exist under perfect competition because of the time it takes for changes in demand and supply conditions to bring new long-run equilibrium. Thus expanding industries will tend to pay higher wage rates than contracting industries. But even after enough time has elapsed for all adjustments to be made to changes in demand and supply, long-run wage differentials will still exist for the following reasons:
Workers do not have identical abilities....
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