Transcript Chapter 8

Chapter 8
THE LABOR MARKET: WAGES,
EMPLOYMENT, AND
UNEMPLOYEMENT
1. Factor Markets
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The circular-flow diagram of Chapter 2 showed that
firms operate simultaneously in two types of markets.
In the product market, they solve the what
problem—what to produce and, if a price searcher,
how much to charge.
In the factor market, firms solve the how problem—
how to combine the factors of production effectively
to produce output.
A factor (input) market is one in which firms
purchase land, labor, or capital inputs.
The price-taking buyer, with a small share of total
market, must simply pay the going market rate.
1. Factor Markets – cont.
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The price-searching buyer, with a sufficiently large
share of the market, can affect the price by buying
more or less of it.
There is less price searching in factor markets than in
product markets.
A firm must thus compete for inputs with all firms
that use the same inputs.
E.g. New York City’s, universities, foundations, major
corporations, etc. all compete against each other for
secretaries, computer programmers, etc.; they do not
compete against each other in product markets, but
they do compete in factor markets.
2. Supply and Demand in
Factor Markets
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Just like prices in product markets, the prices
of labor, capital, and land are determined by
supply and demand.
As there are market supply and demand for
curves for goods, so there are market supply
and demand curves for the factors of
production.
This chapter focus on labor, but the principles
apply to all three factor productions.
2.1 The Supply Factor
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The supply of all the factors of production—
labor, land and capital—depends on their
opportunity costs.
For example the amount of unskilled labor
offered at different wage rates depends on
the alternatives sacrificed in other lines of
employment.
If the wage rate offered for garbage
collection is low, fewer unskilled workers will
conclude that garbage collection is superior to
their next-best alternative.
2.1.1 The Supply Curve
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The supply curve of a factor of production
is the quantity offered at different factor
prices; all other things remaining the same.
The opportunity cost principle reveals a
normal shape to this supply curve.
The higher the factor price (the wage), the
larger the quantity of the factor typically
supplied, ceteris paribus.
2.2 The Demand for a
Factor
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The demand for the factors of
production depends on the productivity
of the factor and the demand for the
product the factor is used to produce.
2.2.1. The Factor Demand
Curve
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The demand curve for a factor shows
the quantities of that factor that would be
purchased (demanded) at different prices,
ceteris paribus.
In most general terms, this demand
depends on two forces: the demand for the
product the factor produces (derived
demand) and the productivity of the factor.
2.2.2. Derived Demand
Firms purchase inputs because they
produce goods and services that can be
sold.
 No matter how productive an input, it
will not be hired unless it produces a
good demanded in the marketplace.
Labor and Derived Demand: The Case of
the Handwritten Bible: Example
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2.2.2. Derived Demand – cont.
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The demand for a factor of production is a
derived demand because it results (is
derived) from the demand for the goods and
services the factor of production helps to
produce.
There is a clear linkage between the demand
for the product the factor produces and the
demand for the factor.
When the demand for new houses falls, there
is unemployment in the lumber-producing
states.
2.2.3. Marginal Productivity
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The marginal product of a factor of production
(MP) is the increase in output that results from
increasing the factor by one unit.
The law of diminishing returns states that as ever
larger quantities of a variable factor will eventually
decline; as the firm expands its output, MP will fall in
the short run.
The marginal product of any factor depends on the
quantity and quality of the cooperating factors of
production (farm worker with modern farm
machinery).
2.2.4. Marginal Revenue
Product
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On the output, side, the firm maximizes profit
by producing that output at which MR=MC.
The marginal revenue product (MRP) of a
factor of production (P) is the extra revenue
generated by increasing the factor by one
unit. MRP = MR x MP
The MRP curve is the firm’s demand curve for
that factor.
2.3. Factor Market
Equilibrium
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The demand for a factor increases whenever
MRP increases. MRP increases when the price
of the product rises or when the marginal
productivity increases.
Increases in the product’s price and in MP
raise factor prices.
An increase in productivity has the same
effect: MRP increases and the demand for the
factor increases, and again the factor prices
rises.
3. Labor Markets
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The prices (wages) of labor of different grades and
types are determined in a labor market.
A labor market brings buyers and sellers of labor
services together to agree on conditions of work and
pay. They can be local, national, or international.
The labor market differs from other factor markets in
four respects:1) people cannot be bought and sold
(no slavery); 2) different job preferences; 3) we have
alternative use of time (leisure vs. work); 4)workers
can join unions.
3.1. Wage Differentials
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Jobs Are Different
Compensating wage differentials are the
higher rewards that must be paid to compensate
for undesirable job characteristics.(Offshore oil
workers vs. food processing workers)
People Are Different
Noncompeting groups are those groups of people
differentiated by natural ability and education,
training, and experience to the extent that they do
not compete with another for jobs. (Dig ditcher vs.
brain surgeon vs. basketball player)
3.2. Human Capital, Productivity,
and Income Distribution
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Human capital is investment in schooling,
training, and health that raises productivity.
Any activity that raises the productivity of a
resource is an investment; e.g. any
expenditure on human capital is as much an
investment as those of a firm building a new
plant or acquiring new machinery.
People acquire additional human capital until
marginal costs and marginal benefits are
equal.
4. The Macroeconomic
Labor Market
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The Employment Act of 1964 commits the
federal government to create and maintain
“useful employment opportunities … for those
able, willing, and seeking to work.”
The Great Depression of the 1930’s with its
high unemployment has left a lasting imprint
on the American consciousness.
In 1929, less than 3 percent of the labor
force was unemployed; by 1933, 25 percent
was unemployed.
4.1 The Definition on
Unemployment
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According to the Bureau of Labor Statistics, a person
is unemployed if he or she:
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Did not work at all during the previous week.
Actively looked for work during the previous four weeks.
Is currently available for work.
The labor force equals the number of persons
employed plus the number unemployed. (People not
in labor force are full-time homemakers or students
and retirees)
The unemployment rate equals the number of
unemployed divided by the labor force (the sum of
employed and unemployed persons). Unemployment
is an indicator of the labor market.
4.2 Frictional and Cyclical
Unemployment
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The unemployed search for jobs; the employed look
for better jobs.
Frictional unemployment is the unemployment
associated with the changing of jobs in a dynamic
economy.
Cyclical unemployment is unemployment
associated with general downturns in the economy.
During cyclical downturns, fewer goods and services
are purchased, employers cut back on jobs, and
people find themselves without jobs.
4.3 Macroeconomic Supply
and Demand for Labor
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The entire economy’s demand for labor depends on
its marginal productivity, which fall as more and more
people are hired; willingness to work depends on the
wage rate.
Real wages are measured by money wages, W,
divided by the price level, P—that is, W/P.
The natural rate of employment is that rate at
which the number of available jobs (V) is equal to the
number of qualified unemployed workers (U).
The natural rate of unemployment is when there is
an approximate balance between the number of
unfilled jobs and the number of qualified job seekers.
4.4 Wage Flexibility and
Unemployment
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If the labor market is like other markets, the wage
should fall whenever there is a gap between the
number of people wishing to work and the number of
jobs available at the prevailing wage.
Much of macroeconomics focuses on why wages are
less flexible than other prices; an explanation is that
labor is often hired under long-term contracts.
If normal wages are inflexible, and the demand for
labor falls, unemployment in excess of the natural
rate can be created.
5. Unions, Layoffs, and
Inflexible Wages
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A labor union is a collective organization of
workers and employees whose goal is to
affect conditions of pay and unemployment.
Currently, about one in nine members of the
American labor force belongs to a union
(↓since 1950—1 out of 4).
Collective bargaining is union bargaining
with management.
5. Unions, Layoffs, and
Inflexible Wages – cont.
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A strike occurs when unionized employees
cease work until management agrees to
specific union demands.
Union’s objectives—higher pay and high
employment of union member are not
compatible; unions must balance these two.
When laid-off union workers want to be
recalled, their unemployment does not cause
wages to fall generally in the economy.