2. Questions: (1) Where do the labor demand and supply curves come from? (2) How well do they explain the facts?

3. The Slowdown in Wage Growth

4. Two sides of the labor market: Firms and Workers Labor Demand –The firm’s decision Labor Supply –The worker’s decision

5. Derived Demand for Labor Labor demand is a derived from firm’s profit maximization decisions Firm chooses output to maximize profits (MC = P) This amount of output implies a level of labor input (short run) –a production function all over again

6. Market power? Not yet, let’s first start with competition A firm in a competitive market for its good: takes price as given But now also assume that the labor market is competitive: firm takes wage as given

7. Example: Competitive Firm with P = $100 (T12.1)

8. To derive the labor demand curve, first plot MRP by hand

9. Marginal Revenue Product Equals Wage Condition for Profit Maximization In symbols: MRP = W For firms in competitive markets: –MRP = PxMP –example 1700 = 100x17 or 1400 = 100x14 This implies that MP = W/P –Marginal product of labor equals real wage

10. To get market demand for labor, sum up firms’ demands for labor

11. What if firm has market power as in a monopoly? Still must have MRP = W But in this case MRP does not equal P=MP –because P is not fixed –P must decrease as L and Q go up

12. Derivation of Labor Supply analogy with earlier analysis of consumer behavior: purposeful choices (work versus “leisure”) with limited resources (only 24 hrs in a day) The “price of leisure” is the opportunity cost of not working = wage As the wage rises, the price of leisure rises –thus the person will work more

13. “Leisure” includes school! Investing in human capital more human capital increase marginal product of a worker

14. Substitution versus income effect in labor supply Recall the two effects for a good –the two effects go in the same direction in case of labor supply the two effects go in opposite directions –hence labor supply can slope down!!!!!!!

15. 3 different labor supply curves

16. Backward bending labor supply curve

17. A Test: compare trend in labor productivity with trend in real wage

18. But productivity theory does not explain everything Compensating wage differentials –salaries in the business school versus the economics department “Efficiency” Wages Long Term Employment Contracts –wage is related to productivity over long periods, but not short periods

19. Effects of Minimum Wage

20. Discrimination in competitive markets

21. Effects of Labor Unions