The Labor Market

Labor Supply The willingness and ability to work a specific amount of time at alternative wage rates in a given time period, ceteris paribus.

Labor Supply QUANTITY OF LABOR (hours per week) WAGE RATE (dollars per hour) Labor supply At higher wages, more labor is supplied B q2 w2 A q1 w1

Income vs. Leisure The opportunity cost of working is the amount of leisure time that must be given up in the process. Opportunity cost is the most desired goods or services that are forgone in order to obtain something else.

Income vs. Leisure As opportunity cost of work increases, we require higher rates of pay. The marginal utility of income declines as more is earned.

Income vs. Leisure The upward slope of individual labor supply curve reflects two things: Increasing opportunity cost of labor. Decreasing marginal utility of income.

Market Supply Market Supply of Labor The total quantity of labor that workers are willing and able to supply at alternative wage rates in a given time period, ceteris paribus.

Market Supply As labor-market entrants increase, quantity of labor supplied goes up.

Labor Demand Demand for Labor The quantities of labor employers are willing and able to hire at alternative wage rates in a given time period.

The Demand for Labor WAGE RATE (dollars per hour) WAGE RATE (dollars per hour) QUANTITY OF LABOR (hours per month) Demand for labor At lower wages, more labor is demanded A L1 W1 B L2 W2

Derived Demand The quantity of resources purchased depends on expected sales and output. The demand for labor depends on the demand for the product that the labor is producing.

Derived Demand The demand for labor and other factors of production results from the demand for goods and services produced by these factors.

The Wage Rate Quantity of labor demanded depends on its price – the wage rate.

Marginal Physical Product The downward slop of the labor-demand curve reflects the changing productivity of workers as more are hired.

Marginal Physical Product We measure a worker’s value to the firm by his or her marginal physical product.

Marginal Physical Product In most situations, marginal physical product declines as more workers are hired.

Marginal Physical Product The change in total output associated with one additional unit of input. Marginal physical product = change in total output change in quantity of labor

Marginal Physical Product

Marginal Physical Product 22 F G 20 E H 18 D 16 I Total output 14 C 12 OUTPUT OF STRAWBERRIES (boxes per hour) 10 B 8 6 b A c 4 d e 2 f g h – 2 Marginal Physical Product (per picker) i – 4 1 2 3 4 5 6 7 8 9 10 NUMBER OF PICKERS (per hour)

Marginal Revenue Product The change in total revenue associated with one additional unit of input. Marginal revenue product = change in total revenue change in quantity of labor

Marginal Revenue Product Marginal revenue product sets an upper limit to the wage rate an employer will pay.

Marginal Revenue Product

The Law of Diminishing Returns The marginal physical product of labor eventually declines as quantity of labor employed increases. Marginal physical product declines as more people must share limited facilities.

The Law of Diminishing Returns The marginal physical product of a variable factor declines as more of it is employed with a given quantity of other (fixed) inputs.

The Law of Diminishing Returns 1 2 3 4 5 6 7 8 9 10 12 14 16 18 20 22 OUTPUT OF STRAWBERRIES (boxes per hour) Total output Marginal output (per picker) A B C D E F G H I b c d e f g h i – 4 – 2 NUMBER OF PICKERS (per hour)

Diminishing Marginal Revenue Product (MRP) As MPP diminishes so does MRP. MRP = MPP X p If p is assumed to be constant, then MRP diminishes along with MPP.

Diminishing Marginal Revenue Product (MRP)

The Hiring Decision How many workers that will be hired is determined by the demand and supply of labor.

The Firm’s Demand for Labor Firm will continue to hire until MRP has declined to level of market wage rate. The MRP curve is labor-demand curve.

The Firm’s Demand for Labor Each (identical) worker is worth no more than the MRP of last worker hired, and all workers are paid the same wage.

The Labor-Demand Curve 1 2 3 4 5 6 7 8 9 10 $11 MARGINAL REVENUE PRODUCT (per hour) QUANTITY OF LABOR (workers per hour) A B Wage rate Wage rate C Wage rate D Wage rate MRP

Market Equilibrium Market demand for labor depends on: Number of employers. MRP of labor in each firm and industry.

Market Equilibrium Market supply of labor depends on: Number of workers. Workers’ willingness to work at alternative wage rates.

Equilibrium Wage The wage at which the quantity of labor supplied in a given time period equals the quantity of labor demanded.

Equilibrium Wage The intersection of market supply and demand curves establishes the equilibrium wage.

Equilibrium Wage It is the only wage where quantity of labor supplied equals quantity of labor demanded.

Equilibrium Wage The Labor Market Market supply The equilibrium wage is set by labor supply and demand we WAGE RATE (dollars per hour) Market demand qe QUANTITY OF LABOR (workers per time period)

Equilibrium Employment The only sustainable level of employment in a market given the prevailing supply and demand conditions.

Changing Market Outcomes Changing market conditions alter wages and employment levels. Changes in labor productivity Changes in the price of the good produced by labor Legal minimum wages Labor unions

Changes in Productivity If labor productivity (MPP) rises, wages can increase without sacrificing jobs.

Changes in Productivity Increased productivity implies that workers can get higher wages without sacrificing jobs or more employment without lowering wages.

Changes in Price Marginal revenue product reflects the interaction of productivity and prices. MRP depends on the market price of the product being produced.

Changes in Price MRP shifts to the right if market price of a product increases.

Shifts in Labor-Demand $12 11 D2 10 D1 9 8 Initial demand curve 7 S WAGE RATE (dollars per hour) 6 5 E 4 Initial wage rate C 3 2 New demand curve 1 1 2 3 4 5 6 7 8 9 QUANTITY OF LABOR DEMANDED (pickers per hour)

Legal Minimum Wages Minimum wages are mandated by Congress.

Legal Minimum Wages Effects of a minimum wage: Reduces the quantity of labor demanded. Increases the quantity of labor supplied. Creates market surplus. Some workers end up better off while others end up worse off.

Workers who keep jobs at higher wage Minimum-Wage Effects Labor demand Labor supply Market surplus D S Minimum wage WAGE RATE (dollars per hour) Workers who keep jobs at higher wage E we Equilibrium wage rate Job losers New entrants who can't find jobs qd qe qs QUANTITY OF LABOR (hours per year)

Labor Unions Workers may take collective action to get higher wages. They form a labor union and bargain collectively with employers.

Labor Unions A union must exclude some workers from the market to get and maintain above-equilibrium wages.

Labor Unions Unions decrease wages in non-union industries. Excluded workers increase non-union labor supply.

The Effect of Unions on Relative Wages (a) Unionized labor market (b) Nonunionized labor market EMPLOYMENT (workers per hour) WAGE (dollars per hour) Demand Market supply Demand Initial supply Later supply wu we we wn l2 l1 l3 n1 n2

Capping CEO Pay Critics of CEO pay levels want to reduce their pay and revise the process used to set their pay levels.

Unmeasured MRP Measuring the MRP of a CEO is difficult because CEO’s contributions are not easy to quantify.

Unmeasured MRP CEO salaries are higher because they reflect their opportunity wage. The opportunity wage is the highest wage an individual would earn in his or her best alternative job.

The Labor Market End of Chapter 8 Irwin/McGraw-Hill © 1999 by The McGraw-Hill Companies, Inc.

Irwin/McGraw-Hill © 1999 by The McGraw-Hill Companies, Inc.