CHAPTER
8
The Labor Market
LEARNING OBJECTIVES
After reading this chapter, you should be able to:
1
2
3
4
5
Cite the forces that influence the supply of labor.
Explain why the labor demand curve slopes downwards.
Describe how the equilibrium wage and employment levels are determined.
Depict how a legal minimum wage alters market outcomes.
Explain why wages are so unequal.
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8-1
LABOR SUPPLY
Individuals offer their time and talents to
those willing to pay.
Labor supply is the willingness and ability
to work specific amounts of time at
alternative wage rates.
• In a given time period
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8-2
LABOR SUPPLY
Individuals must decide how many hours
to work at a given wage rate.
• The opportunity cost of working is the
amount of forgone leisure time.
• Supplying labor hours requires a tradeoff between labor income and leisure.
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8-3
LABOR SUPPLY
Working more hours causes leisure to be
more scarce.
As the quantity of labor increases:
1. Decreasing marginal utility of income.
2. Increasing opportunity cost of labor.
Working more hours requires a higher
wage rate.
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8-4
WAGE RATE (dollars per hour)
LABOR SUPPLY
Labor supply
B
w2
At higher wages, more
labor is supplied.
A
w1
0
q1
q2
QUANTITY OF LABOR (hours per week)
More labor is supplied only at higher
wage rates.
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8-5
LABOR SUPPLY
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.
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8-6
LABOR DEMAND
Employers seek a certain number of
workers at specific wage rates.
Demand for labor is the quantities of labor
employers are willing and able to hire at
alternative wage rates.
• In a given time period.
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8-7
LABOR DEMAND
The amount of factor inputs to produce a
certain output is identified by profit
maximization.
• Quantity of resources a business
demands depends on the firm’s
expected sales and output.
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8-8
LABOR DEMAND
Increased sales will increase a firm’s
demand for labor (and other resources).
Derived demand is the demand for labor
and other factors of production is derived
from the demand for the final goods and
services produced by these factors.
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8-9
LABOR DEMAND
What Does Your Major Pay?
•
•
•
•
•
•
•
•
Petroleum Engineering
Computer Science
Civil Engineering
Economics
Accounting
History
Philosophy
Sociology
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$98,000
$58,400
$53,800
$48,500
$44,300
$39,000
$38,306
$36,000
8-10
LABOR DEMAND
At lower wage rates, marginal cost is
reduced and firms seek to hire more
workers to produce higher output.
• The quantity of labor demanded
depends on the wage rate.
• Higher the wage rate, the lower the
quantity of labor demanded.
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8-11
WAGE RATE (dollars per hour)
LABOR DEMAND
Demand for labor
W1
W2
At lower wages, more
labor is demanded
A
B
0
L1
L2
QUANTITY OF LABOR (hours per month)
The downward slope reflects the changing
productivity of workers as more are hired.
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8-12
LABOR DEMAND
A worker’s value to the firm is his or her
marginal physical product.
The marginal physical product is the
change in total output associated with one
additional unit of an input:
MPP
=
Change in total output
Change in quantity of labor
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8-13
LABOR DEMAND
While productivity is important, the value
of a worker is the worker’s marginal
revenue product.
The marginal revenue product is the
change in total revenue associated with
one additional unit of input:
MRP =
Change in total revenue
Change in quantity of labor
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8-14
LABOR DEMAND
MRP sets an upper limit to the wage rate
an employer will pay.
• The law of diminishing returns causes
the MPP to decline as the quantity of
labor employed increases.
• This is due to more people sharing a
fixed quantity of equipment/facilities.
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8-15
OUTPUT OF STRAWBERRIES (boxes per hour)
LABOR DEMAND
22
20
F
E
21
G
H
D
Total output
16
14
•
I
C
12
10
8
6 A
4
2
0
-2
-4
•
•
B
Total output rises with each
additional worker.
The rise in output slows, implying
MPP is falling to zero.
After point G, no additional workers
are hired.
MPP diminishes as
more workers hired
b c
d
e
f
g
Marginal physical
product per picker
h
i
0 1 2 3 4 5 6 7 8 9 10
NUMBER OF PICKERS (per hour)
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8-16
LABOR DEMAND
The change in MPP is the same as the
change in MRP.
• The relationship between MPP and
MRP:
MRP = MPP x p
where p is output price.
• Assuming p is constant implies MRP
diminishes with MPP.
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8-17
LABOR DEMAND
Number of Total
Pickers
Strawberry
(per Hour) Output
(Boxes per
Hour)
Price of
Strawber
ries (per
Box)
Total
Revenue
(per hour)
Marginal
Revenue
Product
0
0
X
$2
=
$0
1 (Marvin)
5
10
$2
$2
=
=
$10
$20
$10
2 (George)
X
X
3
14
X
$2
=
$28
$8
4
17
X
$2
=
$34
$6
5
19
X
$2
=
$38
$4
6
20
X
$2
=
$40
$2
7
20
X
$2
=
$40
$0
8
18
X
$2
=
$36
$-4
9
15
X
$2
=
$30
$-6
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$10
8-18
LABOR DEMAND
The number of workers that will be hired
by a firm is determined by the demand for
and the supply of labor.
• An employer is willing to pay a worker
no more than MRP.
• In practice, workers typically receive the
same wage rate at the same firm.
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8-19
LABOR DEMAND
A firm will continue to hire as long as the
next worker’s MRP is greater than the
market wage rate.
• As more workers are hired, MRP falls.
• Hiring stop when the last worker hired
has MRP = wage rate.
• MRP curve is the labor demand curve.
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8-20
MARGINAL REVENUE PRODUCT (per hour)
LABOR DEMAND
$11
10
A
B
Hiring continues until
MRP = wage
9
8
7
6
5
4
MRP
C
Wage rate
D
3
2
1
0
1
2
3
4
5
6
7
8
9
QUANTITY OF LABOR (workers per hour)
Firms hire workers until MRP = wage rate.
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8-21
EQUILIBRIUM
Market demand of labor depends on:
1. The number of employers.
2. The MRP of labor in each firm and the
industry.
Market supply of labor depends on:
1. The number of workers.
2. Each workers’ willingness to work at
alternative wage rates.
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8-22
EQUILIBRIUM
WAGE RATE (dollars per hour)
The labor market
Market Supply
we
The equilibrium wage is set
by labor supply and demand
Market Demand
qe
QUANTITY OF LABOR (workers per time period)
The intersection of supply and demand
establishes equilibrium wage.
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8-23
CHANGING MARKET OUTCOMES
The following changes in market conditions
alter wages and employment levels.
1. Changes in labor productivity.
2. Changes in the price of the good
produced by labor.
3. Changes in the legal minimum wage.
4. The actions of labor unions.
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8-24
CHANGING MARKET OUTCOMES
1. If labor productivity (MPP) rises, wages
can increase without sacrificing jobs.
WAGE RATE (dollars per hour)
$12
11 D2
12 D1
9
Initial
8 demand
curve
7
6
5
4
3
2
1
• MRP shift outward.
New demand curve
• All workers earn
higher wages.
S
• Equilibrium number
E
C
Initial
of workers occurs at a
wage rate
Higher productivity higher level of
or prices increase
demand for labor employment.
0
1 2 3 4 5 6 7 8 9
QUANTITY OF LABOR (pickers per hour)
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reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
8-25
CHANGING MARKET OUTCOMES
2. As the market output price increases,
MRP shifts to the right, and equilibrium
can occur at a higher level of employment.
• A higher output price requires a change
in market supply or demand for the
good.
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8-26
CHANGING MARKET OUTCOMES
WAGE RATE (dollars per hour)
3. Minimum wages raises wages, but
causes unemployment.
Labor demand
Labor supply
Market surplus
wm
D
Minimum wage
we
E
Workers
who keep jobs
At higher wage
0
S
Equilibrium wage rate
Job
losers
qd
New entrants who
can’t find jobs
qe
qd
QUANTITY OF LABOR (hours per year)
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8-27
CHANGING MARKET OUTCOMES
4. Workers may form a labor union and
bargain collectively with employers to get
higher wages.
• A union must exclude some workers
from the market to get and maintain an
above-equilibrium wage.
•
Excluded workers increase non-union labor
supply.
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8-28
CHANGING MARKET OUTCOMES
Unions shift workers to nonunionized
labor markets and decrease their wages.
Union wage
wu
Market
supply
we
Market
demand
0
l2 l1 l3
EMPLOYMENT (workers per hour)
WAGE (dollars per hour)
WAGE (dollars per hour)
(a)Unionized labor market
(b) Nonunionized labor market
Initial
Later
Demand
supply supply
we
wn
0
n1 n2
EMPLOYMENT (workers per hour)
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8-29
SHOULD CEO PAY BE CAPPED?
Critics of chief executive officer (CEO) pay
want to revise the process used to set CEO
pay levels.
• MRP of a CEO is difficult to assess.
• CEO salaries are higher because they
reflect the CEO’s opportunity wage.
• Opportunity wage is the highest wage
an individual would earn in his or her
best alternative job.
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8-30