1. Chapter 9 Labor Economics

2. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-2 Learning Objectives Determine why the demand curve for labor slopes downward. List some of the reasons why the demand curve for labor will shift and why the supply curve for labor will shift. Explain why raising the federal minimum wage typically leads to higher unemployment among unskilled workers. State one of the major roles of a labor union. Describe the determinants of the differences in income.

3. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-3 What Determines the Total Supply of Labor? Numerous factors enter into your decision about how many hours to work in a particular job. The single most important determinant of your quantity of labor supplied is how much you are paid.

4. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-4 Figure 9-1: The Supply of Labor Curve for One Individual

5. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-5 Supply of Labor Because the cost of leisure is its opportunity cost, the higher the after-tax wage rate, the larger the quantity of labor supplied. This is called the substitution effect. As after-tax raises increase, eventually workers become so rich they want to buy more of everything, including leisure, so that the quantity supplied of labor actually starts to fall. This is called the income effect.

6. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-6 The Demand for Labor The demand for labor is a derived demand, derived from the demand for a final good or service. All other things held constant, the greater the demand for the final good or service being produced, the greater the demand for workers.

7. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-7 The Demand for Labor (cont.) The two factors that determine the value of a worker to an employer are: 1.how much product a worker can produce in a given time period, and 2.how much each unit of that product is worth.

8. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-8 Marginal Physical Product The marginal physical product (MPP) of labor is the change in output resulting from employing one more worker, holding all other factors of production constant. The law of diminishing marginal returns predicts that additional units of labor will, after some point, cause the MPP to decline, other things held constant.

9. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-9 Marginal Revenue Product Marginal revenue product (MPR) represents the incremental worker’s contribution to the firm’s total revenues. We calculate the MPR by multiplying the marginal physical product by the marginal revenue of the firm. This translates the physical product that results from hiring an additional worker into a dollar value.

10. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-10 Marginal Factor Cost The marginal cost of workers is the extra cost incurred in employing an additional unit of that factor of production. We call that cost the marginal factor cost (MFC).

11. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-11 General Rule for Hiring The firm hires workers up to the point at which the additional cost associated with hiring the last worker is equal to the additional revenue generated by the worker. In a perfectly competitive market, this is the point at which the wage rate equals the marginal revenue product (MRP).

12. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-12 Equilibrium Equilibrium for the firm is obtained when the firm’s demand curve for labor, which turns out to be its MRP curve, intersects the firm’s supply curve for labor, shown as s in Figure 9-2, next.

13. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-13 Figure 9-2: Equilibrium

14. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-14 Reasons for Labor Demand Curve Shifts Because the demand for labor or any other variable input is a derived demand, the labor demand curve will shift if there is a shift in the demand for the final product. A change in the demand for the final product that labor is producing will shift the market demand curve for labor in the same direction.

15. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-15 Reasons for Labor Demand Curve Shifts (cont.) A change in labor productivity will shift the market labor demand curve in the same direction. A change in the price of a substitute input will cause the demand for labor to change in the same direction.

16. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-16 Reasons for Labor Demand Curve Shifts (cont.) A change in the price of a complementary input will cause the demand for labor to change in the opposite direction.

17. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-17 Determinants of the Industry Supply of Labor Changes in wages rates across industries. Changes in working conditions in an industry can also affect its labor supply curve. Job flexibility may also determine the position of the labor supply curve.

18. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-18 The Minimum Wage Not all labor markets are unrestricted. Nationwide, there is a federal minimum wage, which is the lowest legal hourly wage rate that may be paid to certain types of workers. The federal minimum wage started at 25 cents per hour in 1938. At that time, 25 cents represented 40 percent of the average manufacturing wage.

19. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-19 Effects on the Quantity of Labor Supplied and Demanded The higher the federal minimum wage, the greater the quantity of unskilled labor supplied. At higher federal minimum wages, a lower quantity of unskilled labor will be demanded.

20. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-20 The Result: A Surplus of Workers at the Minimum Wage Rate If the federal government sets the minimum wage rate above the equilibrium wage rate, the inevitable will result: A surplus of workers at that relatively high wage rate. This surplus of workers represents higher unemployment.

21. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-21 Figure 9-4: The Results of Setting the Minimum Wage above the Market Clearing Wage Rate

22. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-22 Organized Labor Labor unions usually help their members if in some way they can restrict supply in order to obtain higher- than-competitive wage rates and benefits—working conditions, job security, health insurance—for their members.

23. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-23 The American Labor Movement In the 1800s, workers began to form unions in an attempt to force employers to improve wages and working conditions. For much of its history, organized labor in this country has been split into two groups: craft unions and industrial unions.

24. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-24 The American Labor Movement (cont.) A craft union is made up of workers in a specific trade like bricklaying. An industrial union is made up of all of the workers in an industry regardless of job or level of skills.

25. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-25 Collective Bargaining Collective bargaining is the process by which unions and its employers negotiate the conditions of employment and wages. At the center of the collective bargaining process is a compromise. Employers desire to keep wages and benefits low in order to have lower labor costs and therefore remain competitive. Labor unions wish to increase wages and benefits for their workers.

26. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-26 Strikes Most collective bargaining negotiations are successful. When negotiations breakdown, a strike—deliberate work stoppage by workers—results. Striking unions may use a boycott to exert more economic pressure against firms in an industry. In a boycott, unions urge the public not to purchase goods or services produced by the company it is striking.

27. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-27 The Goals of the Union One of the major roles of a union that succeeds in establishing a wage rate above the market clearing wage rate is to ration available jobs among the surplus of workers who wish to work in unionized industries.

28. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-28 Income Distribution Workers can each expect to be paid their marginal revenue product. This means that, if they increase their marginal physical product, they can expect to be paid more. Some of the determinants of marginal physical product are: talent, experience and training.

29. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-29 Income Distribution Investment in human capital— education—pays off, for each additional degree earned results in a markedly higher average income. Inheritance and discrimination may affect income differences, although inheritance accounts for only 10 percent of income inequality in the United States.

30. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.9-30 Key Terms and Concepts boycott collective bargaining craft union derived demand income distribution income effect industrial union labor productivity labor unions marginal factor cost (MFC) marginal physical product (MPP) of Labor marginal revenue product (MRP) minimum wage strike substitution effect