Labor Markets Derived Demand for Workers Chapter 16

Recap Factors of Production: –Labor, Capital, Entrepreneurship These factors are compensated by paying: –Wage, Rent, Profits How are Wages/Rents Determined ? We focus on Demand and Supply of Labor and determination of Wages. Then discuss about the optimal level of hiring labor by a firm.

Labor Markets Demand for Labor is derived from the demand for a firm’s product Firms hire/fire workers based on the demand for its products Demand and Supply of labor can be modeled like a goods market with one change: price is now called wage

S D Q of Labor Wage to each labor Note that firms demand labor; consumers supply labor

Wages The wage that a firm is willing to pay for a unit of labor is based on the dollar value of the labor’s productivity. An employee’s daily wage should not rise above their dollar contribution to the firm. Wages are tied to the individual’s Marginal Revenue product Changes in demand and supply of labor changes the wage.

Factors Influencing Labor Demand Increases in Human Capital Changes in Technology Changes in the price of the product Changes in the quantity/price of other inputs Changes in the number of firms in the market

Factors Influencing Labor Supply Increases in Population Changing Demographics Changing Alternatives

Labor Demand Labor demand is subject to the “Law of Diminishing Marginal Product” Recall MP L = Marginal (Physical) Product of Labor =  TP/  L We must also be concerned with MRP – Marginal Revenue Product MRP=  TR/  L  Marginal Revenue Product of Labor: The change in a firm’s revenue as a result of hiring one more worker.

Labor Demand Note that except for perfect competition, firms face downward sloping demand curves, This means that the MRP declines as more output is produced This indicates a declining value of labor productivity

Optimal Level of Labor to hire Wages will be set so that they equal MRP Wages = MRP  MC = MB, a familiar expression.