Chapter 28 Labor Demand and Supply (How many laborers should a firm hire, and at what wage?)

The Factor Market – Perfect Competition In the factor market households supply their labor, capital and natural resources in markets that are perfectly competitive, or 1 of the imperfect forms of competition. In the factor market households supply their labor, capital and natural resources in markets that are perfectly competitive, or 1 of the imperfect forms of competition. Perfect Competition: Perfect Competition: –Supply of labor is perfectly elastic –At equilibrium wage rate the firm can hire as many laborer as it wants to

Marginal Physical Product (MPP) - ∆ in output that results from the addition of 1 more worker (MPP) - ∆ in output that results from the addition of 1 more worker –Declines due to diminishing marginal returns Marginal Revenue Product: the incremental worker’s contribution to the firm’s total revenue Marginal Revenue Product: the incremental worker’s contribution to the firm’s total revenue Marginal Factor Cost: the wage rate of each worker Marginal Factor Cost: the wage rate of each worker = ∆ in TC(See pg. 677) = ∆ in TC(See pg. 677) ∆ in amount of resource used ∆ in amount of resource used - Wage rate = $830 In a PC market this is also the perfectly elastic supply curve - firm can purchase all the labor it wants at this wage (Panel b)

Hiring Rule Hire to the point where add.’l cost of hiring 1 more worker = add.’l revenue generated by that worker Hire to the point where add.’l cost of hiring 1 more worker = add.’l revenue generated by that worker –For perfect competition this is = to wage rate = MRP –Panel b p s wage rate d curve is the MRP E is where the 2 intersect (MFC = MRP)

Derived Demand Labor demanded b/c it is used to produce output that will be sold for a profit Labor demanded b/c it is used to produce output that will be sold for a profit If the price of the product produced rises or falls, the MRP will shift accordingly, & fewer or more workers will be needed If the price of the product produced rises or falls, the MRP will shift accordingly, & fewer or more workers will be needed

Market Demand for Labor (28-3 p. 681) $ people - market supply of 2000 $ people - market supply of 2000 Wage decrease to $10 means more hired up to 15 Wage decrease to $10 means more hired up to 15 As firms hire more, supply increases & price of the product will fall As firms hire more, supply increases & price of the product will fall (Panel a) MRP curve shifts L to d1 & each firm’s labor increases to 15 - market Q is 3000 (Panel a) MRP curve shifts L to d1 & each firm’s labor increases to 15 - market Q is 3000

Determinants of Demand Elasticity for Inputs % ∆ in Qd / % ∆ in price of labor % ∆ in Qd / % ∆ in price of labor –Less than 1 = inelastic –= 1 = unit-elastic –More than 1 = elastic Determinants – greater if: Determinants – greater if: –Pe for final product is greater –Input is easily substituted –Larger proportion of total costs accounted for by a particular variable input –Longer time period being considered

Wage Determination Supply curve for labor sloped up for industry Supply curve for labor sloped up for industry –Individual firm can hire all they going rates, (b/c the firm represents such a small part of the market) – so the firm’s supply curve for labor is perfectly elastic –If industry wage rate goes up or down surpluses & shortages are created, but competition will again lead to an equilibrium

Other Wage Determination Theories Efficiency Wages - higher-than- competitive wage rates: Efficiency Wages - higher-than- competitive wage rates: –Workers have more incentive to be productive so they can keep their higher paying job Insiders Versus Outsiders: Insiders Versus Outsiders: –Current employees “with pull” create barriers to entry for outsiders who are willing to work for lower real wages

Shifts in Market Demand & Supply of Labor Demand Curve Shifts: Demand Curve Shifts: –∆ in demand for final product shifts that market DC for labor in the same direction –∆ in labor productivity shifts the labor DC in the same direction, due to more capital, technological improvements, etc. –∆ in P of a substitute input will cause demand for labor to ∆ in same direction –∆ in P of complementary input will cause the D for labor to ∆ in opposite direction Supply of Labor Determinants: Supply of Labor Determinants: –∆ in wage rates of another industry –∆ in working conditions in an industry –Job flexibility

Monopoly in the Product Market For anything other than PC the DC for its product is downward sloping For anything other than PC the DC for its product is downward sloping –P must fall to sell more –MR is continuously falling –Monopolist will continue to product as long as additional profits are made, despite hiring more workers Until wage rate = add.’l revenues (MRP) Until wage rate = add.’l revenues (MRP) –Monopolists hire fewer workers b/c they must account for declining product price

Profit Maximization – Cost Minimization Profit-maximizing combination of resources: Profit-maximizing combination of resources: –MRP of labor = price of labor –MRP of capital = price of capital –MRP of land = price of land Cost minimization: Cost minimization: –MPP of labor = MPP of capital = MPP of land price of labor price of capital price of land price of labor price of capital price of land