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Intersectoral labour allocation, wage-employment bargaining and monopolistic competition

This paper presents a two-sector general equilibrium model: one sector is monopolistically competitive and characterised by wage-employment bargaining at firm level; the other sector is perfectly competitive in both the product and the labour markets and it produces an intermediate good for the first sector. It is shown that: (a) an increase in unions' power over employment lowers firm ef- ficiency but raises total employment and, if unions have more power over wage than over employment, also consumption and welfare; (b) a decrease in unions' power over wage increases total employment but, if unions have more power over employment than over wage and labour supply is rigid, it reduces consumption and welfare; (c) an increase in product market competition generally raises em- ployment, consumption and welfare. The reason why increasing product market competition is almost always beneficial while changing unions' bargaining power can be sometimes harmful is that making the output market more competitive always improves the intersectoral allocation of labour while changing unions' bar- gaining power may make it worse.