Deficiency in the Neo-Classical Labour Market Model and Possible Solution - Essay Example

Neo-Classical theorists argue that households are suppliers of labour, and that they are rational in seeking to maximize their usefulness in return for payment. In the Neo-Classical model this usefulness are determined by the choice of workers between work and leisure, which is also constrained by the available hours per day. The graph below gives indication of a workers choice of allocating time between work and leisure. Point A in graph 1 gives an indication of what a worker's usefulness may be with the choice he makes between work and leisure.

However, this graph will be influenced by other variables as well, such as the wage rate and the cost of living. If for example the wage rate rises, workers will forgo more of their leisure time and increase working hours to earn more. On the graph point W1 shift to W2 when wages increase, and this leisure time decrease to point L2, as less time is available due to more time being spend at work. The marginal revenue product of labour can be used as the demand for labour curve for this firm in the short run.

In competitive markets, a firm faces a perfectly elastic supply of labour which corresponds with the wage rate and the marginal resource cost of labour. In a inperfect market this curve will have to be adjusted to reflect the wage rate divided by marginal costs.Graph 3: Labour Market Demand Curve In a perfect world the supply and demand curve would have adjusted to the optimal equilibrium point through market influences alone. The amount of workers in the market would compete on the same level for the available jobs and the wages firms will be willing to pay for labour.

But due to facts such as unions, automation, economical sentiment, the actual productivity of workers and continuous unemployment rate the Neo-Classical method is insufficient to predict how the labour market behaves in reality. Theorist argues that one of the reasons the Neo-Classical method is not working is due to the fact that employees already in the market are protected and those that is outside the market, the unemployed or those looking for alternative work cannot compete on the same level with the employed.

This is called the inside/outside theory, and according to Blanchard and Summers(1986, 1987) when an employment shock takes place, and workers loose their jobs, they not only become un-employed but loose their protection from the real market, such as their union membership.1 This prevents the labour market's rapid return to pre-shock employment levels. This theory is supported by Lindbeck and Snower (1988, 2001) as they argue that the cost to Firms in replacing their employees with un-employed will dramatically increase their turn-over cost.

Turn-over cost includes hiring, training and firing cost, making it unprofitable for firms to employ outsiders. They also continue by arguing that newly employed workers have to go through several stages before they are accepted as insiders. Layard et al (1991), identified that workers that became unemployed and stayed unemployed for long will