1. Chapter 8: The Labor Market
This chapter deals with the labor market and how wages are determined. It examines labor demand and labor supply and what changes the equilibrium wage rate and employment level.
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.

2. Labor Supply
The willingness and ability to work specific amounts of time at alternative wage rates in a given time period, ceteris paribus.
Labor supply is the willingness and ability to work specific amounts of time at alternative wage rates in a given time period, ceteris paribus. We can derive a supply of labor curve. At higher wages, more labor is supplied.
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3. Income versus 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.
The opportunity cost of working is the amount of leisure time that must be given up in the process. By working, an individual gives up leisure time. The value of this free time represents the opportunity cost. As stated earlier, opportunity cost is the most desired goods or services that are foregone in order to obtain something else.
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4. Income versus Leisure
As the opportunity cost of work increases, we require higher rates of pay.
The marginal utility of income declines as more is earned.
The upward slope of an individual labor supply curve reflects two things:
Increasing opportunity cost of labor.
Decreasing marginal utility of income.
As the opportunity cost of work increases, we require higher rates of pay. The marginal utility of income declines as more is earned. In other words, the additional income is not as satisfying. The upward slope of an individual labor supply curve reflects two things: the increasing opportunity cost of labor and the decreasing marginal utility of income. So the supply of labor curve slopes upward (like a normal supply curve), indicating that as the wage rate increases, the quantity supplied of labor will also increase.
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5. 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.
As labor-market entrants increase, the quantity of labor supplied goes up.
The market supply of labor is the total quantity of labor that workers are willing and able to supply at alternative wage rates in a given time period, ceteris paribus. It represents the supply of all workers. As labor-market entrants increase, the quantity of labor supplied goes up.
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6. 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, ceteris paribus.
The demand for labor shows the quantities of labor employers are willing and able to hire at alternative wage rates in a given time period, ceteris paribus. The demand for labor refers to the number of workers hired or employed (or the number of workers in demand at that wage rate).
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7. Derived Demand
The quantity of resources purchased by a business depends on the firm’s expected sales and output.
The demand for labor depends on the demand for the product that the labor is producing.
The demand for labor is a derived demand. The quantity of resources purchased by a business depends on the firm’s expected sales and output. The demand for labor depends on the demand for the product that the labor is producing. In other words, the demand for labor is contingent on (or derived from) the demand for the final product it is used to produce.
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8. Derived Demand
Derived Demand–The demand for labor and other factors of production results (is derived) from the demand for the final goods and services produced by these factors.
The demand for labor and other factors of production results (is derived) from the demand for the final goods and services produced by these factors. For example, if the demand for shoes goes up, the demand for leather and workers to make the shoes will also go up.
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9. The Wage Rate
The quantity of labor demanded depends on its price–the wage rate.
The quantity of labor demanded depends on its price – the wage rate. The wage rate is simply the price of labor.
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10. Marginal Physical Product (MPP)
We measure a worker’s value to the firm by his or her marginal physical product (MPP).
We measure a worker’s value to the firm by his or her marginal physical product (MPP).
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11. Marginal Physical Product (MPP)
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 (MPP) is the change in total output associated with one additional unit of input. MPP is the extra or additional output from adding one more resource or worker. Marginal physical product equals the change in total output divided by the change in the quantity of labor.
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12. Marginal Physical Product (MPP)
In most situations, the marginal physical product declines as more workers are hired.
In most situations, the marginal physical product declines as more workers are hired. After a while, the additional workers become less productive, so their MPP goes down.
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13. Marginal Physical Product (MPP) Graph After a while, the additional workers become less productive, so their MPP goes down.
This graph depicts the date from the previous table where the marginal physical product declines as more workers are hired.
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14. Marginal Revenue Product (MRP)
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 (MRP) is the change in total revenue associated with one additional unit of input. MRP is the extra or additional revenue from adding one more resource or worker. Marginal revenue product equals the change in total revenue divided by the change in the quantity of labor.
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15. Marginal Revenue Product (MRP)
Marginal revenue product sets an upper limit to the wage rate an employer will pay.
Marginal revenue product sets an upper limit to the wage rate an employer will pay. This is the maximum amount an employer can afford to pay the worker.
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16. The Law of Diminishing Returns
The marginal physical product of labor eventually declines (or diminishes) as the quantity of labor employed increases.
Marginal physical product declines as more people must share limited facilities.
The marginal physical product of labor eventually declines (or diminishes) as the quantity of labor employed increases. Marginal physical product declines as more people must share limited facilities. As more workers are added, eventually the additional output will start to go down or diminish. These extra workers are simply not needed and are less productive.
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17. The Law of Diminishing Returns Graph 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 states that the marginal physical product of a variable factor declines as more of it is employed with a given quantity of other (fixed) inputs. Again, this means that the resources are not as valuable to the firm.
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18. 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.
As MPP diminishes so does MRP. Marginal revenue product equals marginal physical product times price. If price is assumed to be constant, then marginal revenue product diminishes along with marginal physical product. MPP and MRP both decrease together.
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19. The Hiring Decision
The number of workers that will be hired is determined by the demand for and supply of labor.
How many workers that will be hired is determined by the demand for and supply of labor. The firm determines the equilibrium quantity of labor from the intersection of the demand for labor and supply of labor curves.
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20. The Firm’s Demand for Labor
A firm will continue to hire until the MRP has declined to the level of the market wage rate.
The Marginal Revenue Product curve is the labor-demand curve.
A firm will continue to hire until the MRP has declined to the level of the market wage rate. The marginal revenue product curve is the labor-demand curve. The firm should keep hiring or adding workers until the marginal revenue product equals the wage rate. Again, MRP represents the firm’s labor demand curve.
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21. The Labor Demand Curve
Each (identical) worker is worth no more than the MRP of the last worker hired, and all workers are paid the same wage rate.
Each (identical) worker is worth no more than the MRP of the last worker hired, and all workers are paid the same wage rate.
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22. Market Equilibrium The market demand for labor depends on:
The number of employers.
The Marginal Revenue Product of labor in each firm and the industry.
The market supply of labor depends on:
The number of workers.
Each workers’ willingness to work at alternative wage rates.
The market demand for labor depends on the number of employers and the marginal revenue product of labor in each firm and the industry. The market supply of labor depends on the number of workers and each workers’ willingness to work at alternative wage rates. As always, equilibrium is determined by the intersection of these two curves.
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23. Equilibrium Wage
The intersection of the market supply and demand curves establishes the equilibrium wage.
It is the only wage where the quantity of labor supplied equals the quantity of labor demanded.
The intersection of the market supply and demand curves establishes the equilibrium wage. There is only one equilibrium. It is the only wage where the quantity of labor supplied equals the quantity of labor demanded.
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24. Equilibrium Employment
The only sustainable level of employment in a market given the prevailing supply and demand conditions.
Equilibrium employment is the only sustainable level of employment in a market given the prevailing supply and demand conditions. This is where the labor market balances or “clears”.
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25. 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
Changing market conditions alter wages and employment levels in several ways. They include changes in labor productivity, changes in the price of the good produced by labor, legal minimum wages, and labor unions. A change in any of these things will change the equilibrium wage rate and employment level.
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26. Changes in Productivity
If labor productivity (MPP) rises, wages can increase without sacrificing jobs.
Increased productivity implies that workers can get higher wages without sacrificing jobs or more employment without lowering wages.
If labor productivity (MPP) rises, wages can increase without sacrificing jobs. Increased productivity implies that workers can get higher wages without sacrificing jobs or more employment without lowering wages. So an increase in labor productivity will increase wage rates but won’t reduce the employment level. It benefits workers as well as employers.
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27. Changes in Price
Marginal revenue product reflects the interaction of productivity and product prices.
MRP depends on the market price of the product being produced.
MRP shifts to the right if the market price of a product increases.
Marginal revenue product reflects the interaction of productivity and product prices. MRP depends on the market price of the product being produced. MRP shifts to the right if the market price of a product increases. So if the price of the product increases this will help the resource.
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28. Legal Minimum Wages Minimum wages are mandated by Congress.
Effects of a minimum wage:
Reduces the quantity of labor demanded.
Increases the quantity of labor supplied.
Creates a market surplus.
Some workers end up better off while others end up worse off (a tradeoff).
Minimum wages are mandated by Congress. The effects of a minimum wage include the following: It reduces the quantity of labor demanded, increases the quantity of labor supplied, and creates a market surplus. Some workers end up better off while others end up worse off, so it illustrates the idea of a tradeoff. A minimum wage acts as a price floor, or an above-equilibrium wage rate. The result is a surplus of workers or increased unemployment. There is disagreement among economists over how significant this is.
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29. Minimum-Wage Effects
This graph shows how a minimum wage acts as a price floor, or an above-equilibrium wage rate. The result is a surplus of workers or increased unemployment.
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30. Labor Unions Workers may take collective action to get higher wages.
They form a labor union and bargain collectively with employers.
A union must exclude some workers from the market to get and maintain an above-equilibrium wage.
Labor unions also very successful at achieving higher wages for their members. Workers may take collective action to get higher wages. They may form a labor union and bargain collectively with employers. A union must exclude some workers from the market to get and maintain an above-equilibrium wage.
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31. Labor Unions Unions decrease wages in non-union industries.
Excluded workers increase non-union labor supply.
Unions decrease wages in non-union industries. The excluded workers increase the non-union labor supply. The effect of this increase in supply is to decrease wages.
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32. Capping CEO Pay
Critics of CEO (Chief Executive Officer) pay levels want to reduce their pay and revise the process used to set their pay levels.
Critics of CEO (Chief Executive Officer) pay levels want to reduce their pay and revise the process used to set their pay levels. Many feel that they make obscene amount of money.
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33. Unmeasured MRP
Measuring the MRP of a CEO is difficult because a CEO’s contributions are not easy to quantify.
CEO salaries are higher because they reflect their opportunity wage:
Opportunity wage is the highest wage an individual would earn in his or her best alternative job.
Measuring the MRP of a CEO is difficult because a CEO’s contributions are not easy to quantify. CEO salaries are higher because they reflect their opportunity wage. Opportunity wage is the highest wage an individual would ear in his or her best alternative job. Again, it is hard to value the worth of a CEO. Their salaries are high because they have a high opportunity cost.
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34. The Labor Market End of Chapter 8
In conclusion, this chapter showed how wages are determined and examined some of the things that affect wages and cause them to change. Workers are demanded based on their productivity or MRP. When this increases, so does the demand for the worker.
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