Unit 5 The rules of the game: Who gets what and why

5.8 Case 3: Bargaining in a democracy

In the final situation, Case 3, Bruno owns the farm and Angela is Bruno’s employee. As in Case 2, Bruno’s property rights and Angela’s right not to agree to a contract are protected by law. But there is an important difference, which leads to a different employment contract from the one in Case 2.

In Case 3, Angela is a voter and is free to seek change in the legal institutional arrangements, together with other farmworkers. She has democratic political rights. Case 3 therefore represents a common economic interaction in modern capitalist economies with a democratic form of government. Angela’s vote, and that of other workers, can bring about legal changes in the rules of the game by influencing the government.

In this section, we describe the legal changes they achieve, and how these affect the contract that Bruno offers Angela. The following section will consider what happens when, rather than simply accepting a take-it-or-leave it offer, she has scope to negotiate further changes with Bruno.

Angela’s and Bruno’s actions and the outcomes when Angela votes for specific worker rights

Suppose that Angela and others who work on neighbouring farms lobby the government to improve their conditions. They want working hours for farm labourers restricted to four and a half hours per day. They also want to get at least the same amount of grain as under the voluntary take-it-or-leave-it contract agreement in Case 2, which was 23 bushels. Angela, and other workers, will vote for the political party that agrees to implement their demands. They use their ability as voters to make legislative demands on the government, thereby influencing their employment contracts.

The government agrees to the demands of the farm labourers, hoping to secure their vote in subsequent elections. So Bruno is constrained to offer a contract with working hours between zero and four and a half hours per day. He must also ensure that Angela gets at least 23 bushels of grain. Work through Figure 5.16 to figure out his choice.

In this diagram, the horizontal axis shows Angela’s hours of free time, and ranges between 0 and 24. The vertical axis shows bushels of grain, and ranges between 0 and 70. Coordinates are (hours, bushels). A downward-sloping, concave curve connects points (0, 64) A (16, 46), M (19.5, 35) and (24, 0) and is labelled feasible frontier. There are two parallel, downward-sloping, convex curves. One passes through point L (16, 23) and is labelled IC2. The other passes through point N (19.5, 23) and is labelled IC_N. IC_N lies above IC2 at all points. The minimum wage is 23 bushels. The maximum working hours is 4.5. The area between point M, a horizontal line through N, and the feasible frontier is the feasible set. The vertical distance between points M and N is Bruno’s share of bushels of grain. The vertical distance between point N and IC2 corresponds to 7 bushels of grain.
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Figure 5.16 The effect of a law setting maximum working hours and minimum pay.

The new law improves Angela’s reservation position: In this diagram, the horizontal axis shows Angela’s hours of free time, and ranges between 0 and 24. The vertical axis shows bushels of grain, and ranges between 0 and 70. Coordinates are (hours, bushels). A downward-sloping, concave curve connects points (0, 64) A (16, 46) and (24, 0) and is labelled feasible frontier. There are two parallel, downward-sloping, convex curves. One passes through point L (16, 23) and is labelled IC2. The other passes through point N (19.5, 23) and is labelled IC_N. IC_N lies above IC2 at all points. The minimum wage is 23 bushels.
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The new law improves Angela’s reservation position

Under the new law, landowners must offer a wage of at least 23 bushels for no more than four and a half hours of work. Angela’s reservation utility has risen: her contract must be at least as good for her as N. ICN is her new reservation indifference curve.

The new law limits Bruno’s options: In this diagram, the horizontal axis shows Angela’s hours of free time, and ranges between 0 and 24. The vertical axis shows bushels of grain, and ranges between 0 and 70. Coordinates are (hours, bushels). A downward-sloping, concave curve connects points (0, 64) A (16, 46) and (24, 0) and is labelled feasible frontier. There are two parallel, downward-sloping, convex curves. One passes through point L (16, 23) and is labelled IC2. The other passes through point N (19.5, 23) and is labelled IC_N. IC_N lies above IC2 at all points. The minimum wage is 23 bushels. The maximum working hours is 4.5. The area between a vertical line through point N, a horizontal line through N, and the feasible frontier is the feasible set.
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The new law limits Bruno’s options

Bruno’s options are now more limited. He must offer a contract in the shaded area: on or below the feasible frontier, with no more than four and a half working hours and a wage of at least 23 bushels. He can no longer choose allocation L.

The contract Bruno will offer: In this diagram, the horizontal axis shows Angela’s hours of free time, and ranges between 0 and 24. The vertical axis shows bushels of grain, and ranges between 0 and 70. Coordinates are (hours, bushels). A downward-sloping, concave curve connects points (0, 64) A (16, 46), M (19.5, 35) and (24, 0) and is labelled feasible frontier. There are two parallel, downward-sloping, convex curves. One passes through point L (16, 23) and is labelled IC2. The other passes through point N (19.5, 23) and is labelled IC_N. IC_N lies above IC2 at all points. The minimum wage is 23 bushels. The maximum working hours is 4.5. The area between point M, a horizontal line through N, and the feasible frontier is the feasible set. The vertical distance between points M and N is Bruno’s share of bushels of grain.
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The contract Bruno will offer

Within the shaded area, Bruno gets the most grain at allocation N. Angela produces 35 bushels (point M) and he gets 12.

Angela will produce less grain and get higher utility: In this diagram, the horizontal axis shows Angela’s hours of free time, and ranges between 0 and 24. The vertical axis shows bushels of grain, and ranges between 0 and 70. Coordinates are (hours, bushels). A downward-sloping, concave curve connects points (0, 64) A (16, 46), M (19.5, 35) and (24, 0) and is labelled feasible frontier. There are two parallel, downward-sloping, convex curves. One passes through point L (16, 23) and is labelled IC2. The other passes through point N (19.5, 23) and is labelled IC_N. IC_N lies above IC2 at all points. The minimum wage is 23 bushels. The maximum working hours is 4.5. The area between point M, a horizontal line through N, and the feasible frontier is the feasible set. The vertical distance between points M and N is Bruno’s share of bushels of grain. The vertical distance between point N and IC2 corresponds to 7 bushels of grain.
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Angela will produce less grain and get higher utility

Under contract N, Angela gets the same wage as in contract L (Case 2), but more free time. This contract puts her on her new reservation indifference curve ICN, seven bushels above IC2. Measured in terms of grain, her utility is seven bushels higher.

Under the new legal constraints, the best Bruno can do is to offer Angela the minimum daily wage (23 bushels) for the maximum number of hours (4.5). To maximize his amount of grain, he keeps the wage as low as possible. And if he gave Angela more free time, less grain would be produced; he would still have to pay her at least 23 bushels, leaving less for himself.

He offers Angela contract N. If Angela accepts, she produces 35 bushels of grain (point M). After paying her wage of 23 bushels, he obtains a rent of 12 bushels. Angela gets her new reservation utility, so her rent is zero. The total surplus (the sum of Bruno’s and Angela’s rents) is 12 bushels.

Although less grain is produced than in Case 2, and Angela still gets no rent, she is undoubtedly better off as a result of the new law. At allocation N, her wage is the same as before, but she has more free time, so we know that her utility is higher. And we can measure the increase in utility: the new law has raised her reservation indifference curve by seven bushels from IC2 to ICN, so her utility has risen by the equivalent of seven bushels of grain.

Figure 5.17 summarizes the allocation. But, as the next section discusses, this may not be the outcome. Both Angela and Bruno can do better.

Angela’s hours of free time 19.5  
Angela’s bushels of grain 23  
Bruno’s bushels of grain 12  
Angela’s economic rent (bushels) 0 She is on ICN, her new reservation indifference curve
Bruno’s economic rent (bushels) 12 His best alternative is 0 (if Angela refuses to work for him)

Figure 5.17 The allocation under contract N, satisfying the new minimum wage and maximum hours law.

Question 5.5 Choose the correct answer(s)

Figure 5.16 shows the outcomes before and after the introduction of a new law that limits Angela’s maximum working hours to four and a half hours a day and requires that she receive at least 23 bushels of grain. Contract N is Bruno’s first offer to Angela. Based on this information, read the following statements and choose the correct option(s).

In this diagram, the horizontal axis shows Angela’s hours of free time, and ranges between 0 and 24. The vertical axis shows bushels of grain, and ranges between 0 and 70. Coordinates are (hours, bushels). A downward-sloping, concave curve connects points (0, 64) A (16, 46), M (19.5, 35) and (24, 0) and is labelled feasible frontier. There are two parallel, downward-sloping, convex curves. One passes through point L (16, 23) and is labelled IC2. The other passes through point N (19.5, 23) and is labelled IC_N. IC_N lies above IC2 at all points. The minimum wage is 23 bushels. The maximum working hours is 4.5. The area between point M, a horizontal line through N, and the feasible frontier is the feasible set. The vertical distance between points M and N is Bruno’s share of bushels of grain. The vertical distance between point N and IC2 corresponds to 7 bushels of grain.
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  • If Angela accepts Bruno’s offer of contract N, the change from L to N would be a Pareto improvement.
  • If Angela accepts Bruno’s offer of contract N, she would be better off than at L.
  • Both Angela and Bruno receive economic rents at N.
  • As a result of the new law, Bruno has less structural power.
  • It is not a Pareto improvement, because Bruno is worse off (gets less grain) at N than at L.
  • Contract N is on a higher indifference curve than L.
  • At N, Angela is on her new reservation indifference curve and therefore does not receive any economic rent. Bruno’s reservation option is to receive nothing, so the grain he receives at N is an economic rent for him.
  • The law has increased Angela’s structural power and reduced Bruno’s, because Angela can now walk away from L. Now her new reservation utility is contract N.