1. Introduction: Thinking Like an Economist 1 CHAPTER Work and the Labor Market Work banishes those three great evils: boredom, vice, and poverty. — Voltaire CHAPTER 17 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2. 1 Work and the Labor Market 17 17-2 Work and the Labor Market  A labor market is a factor market in which individuals supply labor services for wages to individuals and firms that demand labor services  Incentive effect is how much a person will change hours worked in response to the wage rate  The labor supply choice is between nonmarket activities and legal market activities Economists focus on the incentive effect when considering an individual’s choice of whether and how much to work

3. 1 Work and the Labor Market 17 17-3 The Supply of Labor The higher the wage, the higher the quantity of labor supplied. The labor supply curve has a positive slope because the opportunity cost of not working increases as wages get higher Wage Rate Q of Labor Supply of Labor

4. 1 Work and the Labor Market 17 17-4 Real Wages and the Opportunity Cost of Work  The upward sloping labor supply curve tells you that, other things equal, as wages go up, the quantity of labor supplied goes up  This is explained by the income effect; higher incomes make people richer, and richer people can afford to choose more leisure causing a decrease in hours worked  Historically real wages have been increasing and people have reduced the number of hours they work, but they still work more hours than predicted

5. 1 Work and the Labor Market 17 17-5 Income Tax, Work, and Leisure  Taxes reduce the net wage of individuals, reducing the incentive to work  For welfare recipients, the tax penalties for working create a great incentive to not work or to work “off the books”  An increase in the marginal tax rate is likely to reduce the quantity of labor supplied  EU countries, which have relatively high marginal tax rates, are struggling with the problem of providing incentives for people to work

6. 1 Work and the Labor Market 17 17-6 The Elasticity of Labor Supply  Elasticity of labor supply depends on: Individuals’ opportunity cost of working The type of labor market being discussed The elasticities of individuals’ supply curve Individuals entering and leaving the labor market  Employees prefer an inelastic labor supply, but employers prefer an elastic labor supply  Estimates for labor supply elasticity are about 0.1 (inelastic) for heads of household and 1.1 (elastic) for secondary earners

7. 1 Work and the Labor Market 17 17-7 Immigration and the International Supply of Labor  International limitations on the flow of people play an important role in elasticities of labor supply  Large differentials in wages mean that many people from low wage countries would like to move to high wage countries to earn higher wages  EU countries have open borders among member countries, allowing the flow of labor between low and high wage countries

8. 1 Work and the Labor Market 17 17-8 The Derived Demand for Labor The demand for labor follows the basic law of demand: the higher the wage, the lower the quantity of labor demanded The demand for labor by firms is a derived demand meaning the demand for factors of production by firms depends on consumers’ demands Wage Rate Q of Labor Demand for Labor

9. 1 Work and the Labor Market 17 17-9 Factors Influencing the Elasticity of Demand for Labor  Four factors that influence the elasticity of demand for labor are: The elasticity of demand for the firm’s good The relative importance of labor in the production process The possibility, and cost, of substitution in production The degree to which the marginal productivity falls with an increase in labor

10. 1 Work and the Labor Market 17 17-10 Labor as a Factor of Production  The traditional factors of production are land, labor, capital, and entrepreneurship  The labor market includes labor and entrepreneurship  Entrepreneurship refers to labor services that require high degrees of organizational skills, concern, oversight responsibility, and creativity  Days of entrepreneurship can be equivalent to weeks and months of non-entrepreneurial labor

11. 1 Work and the Labor Market 17 17-11 Rule for employing labor: MRP = MRC Marginal Revenue Product = Change in Total Revenue Unit Change in Resource Quantity Marginal Resource Cost = Change in Total (Resource) Cost Unit Change in Resource Quantity Marginal Revenue Product (MRP) Marginal Resource Cost (MRC)

12. 1 Work and the Labor Market 17 17-12 Resource Wage (Wage Rate) Quantity of Resource Demanded (1) Units of Resource (2) Total Product (Output) (3) Marginal Product (MP) (4) Product Price (5) Total Revenue, (2) X (4) (6) Marginal Revenue Product (MRP) 0123456701234567 0 7 13 18 22 25 27 28 76543217654321 $2 2 $ 0 14 26 36 44 50 54 56 $14 12 10 8 6 4 2 ] ] ] ] ] ] ] ] ] ] ] ] ] ] 1234567 0 -2 2 4 6 8 10 12 14 16 $18 D=MRP Purely Competitive Firm’s Demand for A Resource

13. 1 Work and the Labor Market 17 17-13 ($10) W C ($10) W C Wage Rate (Dollars) Labor Market Quantity of Labor Wage Rate (Dollars) Individual Firm Quantity of Labor QCQC (1000) 00 d=mrp qCqC (5) s=MRC Competitive Labor Market D=MRP (∑ mrp’s) S e b a c

14. 1 Work and the Labor Market 17 17-14 Equilibrium in the Labor Market Equilibrium is where the quantity demanded of labor is equal to the quantity supplied Wage Rate Q of Labor Demand for Labor Supply of Labor QeQe WeWe Equilibrium wage is W e Equilibrium quantity is Q e

15. 1 Work and the Labor Market 17 17-15 Shift Factors of Demand  Technology both increases/decreases the demand for labor  International competitiveness may increase the demand for labor in the U.S. in spite of lower wages in foreign countries because: U.S. workers may be more productive Transportation costs are lower Potential trade restrictions Production techniques are not compatible with foreign social institutions Focal point phenomenon is a situation where a company moves to a country because others have already moved there

16. 1 Work and the Labor Market 17 17-16 Determination of Wages  Supply and demand forces strongly influence wages, but they do not fully determine wages  Real-world labor markets are filled with examples of individuals or firms who resist these supply and demand pressures: Labor unions Professional associations Agreements among employers

17. 1 Work and the Labor Market 17 17-17 Labor Market in Action The effect of an above equilibrium wage is an excess supply of labor and jobs must be rationed Wage Rate Q of Labor Demand for Labor Supply of Labor QDQD W1W1 QSQS Excess supply of labor WeWe

18. 1 Work and the Labor Market 17 17-18 Labor Market in Action The effect of an increase in the supply of labor will cause: Wage Rate Q of Labor D S0S0 Q0Q0 W1W1 Q1Q1 W0W0 Equilibrium wage to decrease Equilibrium quantity to increase S1S1

19. 1 Work and the Labor Market 17 17-19 The Labor Market and You  Consider relative pay of jobs requiring a college degree compared to jobs requiring only a high school diploma  Consider the salaries of Ph.D.s compared to the salaries of MBAs  Among jobs you like, choose a job in a field in which the supply of labor is limited, or the demand for labor is significantly increasing  Jobs in which the supply will likely be limited are those in which social or political forces have placed restrictions on entry or those requiring special abilities

20. 1 Work and the Labor Market 17 17-20 Labor Demand  Consider relative pay of jobs requiring a college degree compared to jobs requiring only a high school diploma  Consider the salaries of Ph.D.s compared to the salaries of MBAs  Among jobs you like, choose a job in a field in which the supply of labor is limited, or the demand for labor is significantly increasing  Jobs in which the supply will likely be limited are those in which social or political forces have placed restrictions on entry or those requiring special abilities