The Labor Market

Chapter 8Copyright © 2011 by The McGraw-Hill Companies, Inc. All Rights Reserved.McGraw-Hill/Irwin

8-2

Labor Supply

• The willingness and ability to work specific amounts of time at alternative wage rates in a given time period, ceteris paribus.

LO-1

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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.

LO-1

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• 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.

Income versus Leisure

LO-1

8-5

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.

LO-1

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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.

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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.

LO-2

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• 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.

Derived Demand

LO-2

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What does your major pay?

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The Wage Rate

• The quantity of labor demanded depends on its price—the wage rate.

• The farmer paying $30 an hour to labor may not hire as much labor as she would at $10 per hour.

LO-3

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Figure 8.2

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Marginal Physical Product (MPP)

• We measure a worker’s value to the firm by his or her marginal physical product (MPP).

LO-3

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• Marginal physical product–the change in total output associated with one additional unit of an input:

MPP = change in total output

change in quantity of labor

Marginal Physical Product (MPP)

LO-3

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• In most situations, the marginal physical product declines as more workers are hired.

Marginal Physical Product (MPP)

LO-3

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Marginal Revenue Product (MRP)

• Marginal revenue product–the change in total revenue associated with one additional unit of input:

MPP = change in total revenue

change in quantity of labor

LO-3

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• Marginal revenue product sets an upper limit to the wage rate an employer will pay.

Marginal Revenue Product (MRP)

LO-3

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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 because more people must share limited facilities.

LO-3

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• The Law of Diminishing Returns–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

LO-3

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Figure 8.3

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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.

LO-3

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Table 8.1

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The Hiring Decision

• The number of workers that will be hired is determined by the demand for and the supply of labor.

LO-3

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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.

LO-3

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• Each (identical) worker is worth no more than the MRP of the last worker hired, and all workers are paid the same wage rate.

The Firm’s Demand for Labor

LO-3

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Figure 8.4

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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. LO-3

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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.

LO-3

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Equilibrium Employment

• The only sustainable level of employment in a market given the prevailing supply and demand conditions.

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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

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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.

LO-5

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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.

LO-5

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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).LO-4

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Figure 8.7

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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.

LO-5

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• Unions decrease wages in non-union industries.– Excluded workers increase non-union

labor supply.

Labor Unions

LO-5

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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.

• The Obama Administration created a Pay Czar position to govern salaries and benefits given to CEOs of firms bailed out during the 2008-09 economic problems.

LO-5

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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.

LO-5

End of Chapter 8