Transcript Chapter 29

Chapter 28
The Labor Market:
Demand, Supply,
and Outsourcing
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Introduction
Since the mid-1990s, a number of U.S. firms, including
International Business Machines (IBM) Corporation,
have been engaging in outsourcing by hiring workers in
foreign countries.
Why are IBM and many other U.S. firms hiring workers
abroad instead of here in the United States?
In this chapter, you will learn the answer to this
question.
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Learning Objectives
• Understand why a firm’s marginal revenue
product curve is its demand labor curve
• Explain in what sense the demand for
labor is a “derived” demand
• Identify the key factors influencing the
elasticity of demand for inputs
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Learning Objectives (cont'd)
• Describe how equilibrium wage rates are
determined for perfectly competitive firms
• Explain what labor outsourcing is and how
it is ultimately likely to affect U.S. workers’
earnings and employment prospects
• Contrast the demand for labor and wage
determination by a product market
monopolist with outcomes that would arise
under perfect competition
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Chapter Outline
• Labor Demand for a Perfectly Competitive
Firm
• The Market Demand for Labor
• Wage Determination in a Perfectly
Competitive Market
• Labor Outsourcing, Wages, and
Employment
• Monopoly in the Product Market
• The Utilization of Other Factors of
Production
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Did You Know That ...
• In Ukraine, when politicians want to have a large
crowd at a political rally, they sometimes turn to
a company called Easy Work, which pays college
students to cheer for politicians?
• The demand for participants at political rallies by
politicians can be studied in much the same
manner as we studied the demand for output.
• A firm will hire employees up to the point at
which the marginal benefit of hiring a worker will
just equal the marginal cost.
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Labor Demand for a Perfectly
Competitive Firm
• We will start our analysis under the
assumption that the market for input
factors
is perfectly competitive
• We will further assume that the output
market is perfectly competitive
• This provides a benchmark against which
to compare other labor markets or product
markets that are not perfectly competitive
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Labor Demand for a Perfectly
Competitive Firm (cont'd)
• Assumptions
– Each employer is one of a very large number of
employers
– Workers do not need special skills
– Workers are free to move from one employer
to another
– The firm is a price taker in the labor market
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Labor Demand for a Perfectly
Competitive Firm (cont'd)
• Marginal Physical Product (MPP) of Labor
– The change in output resulting from the
addition
of one more worker
– The change in total output accounted for by
hiring the worker, holding all other factors of
production constant
– Eventually declines because of the law of
diminishing marginal product
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Labor Demand for a Perfectly
Competitive Firm (cont'd)
• Marginal Revenue Product (MRP)
– The marginal physical product (MPP)
times the marginal revenue (MR)
– The additional revenue obtained from a
one-unit change in labor input
– The MRP represents the incremental worker’s
contribution to the firm’s total revenues
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Figure 28-1 Marginal Revenue Product,
Panel (a)
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Figure 28-1 Marginal Revenue Product,
Panel (b)
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Labor Demand for a Perfectly
Competitive Firm (cont'd)
• Marginal Factor Cost (MFC)
– The cost of using an additional unit of
an input
– For example, if a firm can hire all the workers it
wants at the going wage rate, the MFC of labor
is the wage rate.
Marginal factor cost =
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change in total cost
change in amount of resources used
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Labor Demand for a Perfectly
Competitive Firm (cont'd)
• In a perfectly competitive labor market
– The market determines the wage
– The individual employer is a wage taker
– All workers are hired for the same wage
– MFC = wage
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Labor Demand for a Perfectly
Competitive Firm (cont'd)
• 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 hiring that worker
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Labor Demand for a Perfectly
Competitive Firm (cont'd)
• The MRP Curve: Demand For Labor
– The MRP curve is the demand curve for labor
for the firm
– This tells us how many workers will be hired at
various possible wage rates
– The firm will hire any worker who can
contribute to revenues by more than they
contribute to costs
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Labor Demand for a Perfectly
Competitive Firm (cont'd)
• Derived Demand
– Input factor demand derived from demand for
the final product being produced
• The factors of production are needed to
manufacture a final good or to provide a
final service
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Figure 28-2 Demand for Labor,
a Derived Demand
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The Market Demand for Labor
• The downward-sloping portion of each
firm’s MRP curve is also its demand curve
for labor
• When we go to the entire market for labor,
we will also find that the quantity of labor
demanded varies inversely with wage rate
changes
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Figure 28-3 Derivation of the Market
Demand Curve for Labor
• Wage rate of $20
• Firms will hire
2,000 workers
• Wage rate of $10
• Firms will hire
3,000 workers
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The Market Demand for Labor
(cont'd)
• Price elasticity of demand for labor similar
to elasticity for goods
• Percentage change in quantity demanded
divided by percentage change in price of
labor
– Inelastic < I
– Unit-elastic = 1
– Elastic > 1
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The Market Demand for Labor
(cont’d)
• Determinants of Demand Elasticity for Inputs
– The price elasticity of demand for a variable input will be
greater:
1. The greater the price elasticity of demand for the final
product
2. The easier it is to employ substitute inputs
3. The larger the proportion of total costs accounted for by
the particular variable input
4. The longer the time period available
for adjustment
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International Example: Globalization of Tasks
and the Elasticity of U.S. Labor Demand
• Economist Mine Senses has found evidence that a
shift toward using foreign labor to perform more
tasks has boosted labor demand elasticities in the
United States by at least 20 percent on average.
• Thus, greater ease of substitution of foreign labor
for labor in the United States has increased
elasticities of U.S. labor demand.
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Wage Determination in a Perfectly
Competitive Labor Market
• Having developed the demand curve for
labor in a particular industry, let’s turn to
the labor supply curve
• By adding supply to our analysis, we can
determine the equilibrium wage rate that
workers earn in an industry, such as in
Figure 28-4
• We can think in terms of a supply
curve for labor that slopes upward in
a particular industry
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Figure 28-4 The Equilibrium Wage Rate and the
Titanium Battery Industry
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Wage Determination in a Perfectly
Competitive Labor Market (cont’d)
• Reasons for labor demand curve shifts
1. Change in demand for the final product
2. Change in labor productivity
3. Change in the price of related factors
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Wage Determination in a Perfectly
Competitive Labor Market (cont’d)
• 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
• A change in labor productivity will shift the
market labor demand curve in the same direction
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Wage Determination in a Perfectly
Competitive Labor Market (cont’d)
• A change in the price of a substitute input will
cause demand for labor to change in the same
direction
• A change in the price of a complimentary input
will cause the demand for labor to change in the
opposite direction
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Wage Determination in a Perfectly
Competitive Labor Market (cont’d)
• Labor supply curves may shift in a
particular industry for a number of
reasons:
1. Change in wages in other industries
2. Changes in working conditions
3. Job flexibility
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International Example: An Increase in the
Demand for Services of Icelandic Translators
• Two recent events increased the derived demand
for Icelandic translation services:
– In 2008 and 2009, Iceland’s banking crisis led European
and U.S. customers of banks in that nation to seek
financial and legal assistance, which in turn required
translations of documents written in the Icelandic
language.
– In 2010, Iceland’s Eyjafjallajökull volcano began to
erupt, raising the demand for media coverage and thus
the demand for Icelandic translators.
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Labor Outsourcing, Wages,
and Employment
• Outsourcing
– A firm’s employment of labor outside the
country in which the firm is located
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Labor Outsourcing, Wages,
and Employment (cont'd)
• Outsourcing
– Some U.S.-based companies outsource labor to
other countries.
– Some firms based around the globe outsource
labor to the United States.
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Figure 28-5 Outsourcing of U.S. Computer
Technical-Support Services
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Labor Outsourcing, Wages,
and Employment (cont'd)
• Question
– How are U.S. workers affected by outsourcing?
• Answers
– If cheaper labor is available in other countries,
this will dampen the demand for U.S. labor
– But as the volume of global commerce rises,
there may be more of a demand by foreign
firms to hire U.S. workers as well
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Labor Outsourcing, Wages,
and Employment (cont'd)
• Labor outsourcing by U.S. firms tends to reduce
U.S. wages and employment
• Whenever foreign firms engage
in labor outsourcing to the United States,
however, U.S. wages and employment increase
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Figure 28-6 Outsourcing of Accounting
Services by Canadian Firms
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Labor Outsourcing, Wages,
and Employment (cont'd)
• Summing up the economic implications of
outsourcing
– Even in the best of times, workers experience
short-run ups and downs in wages and jobs. In
the United States, after all, about 4 million jobs
come and go every month.
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Labor Outsourcing, Wages,
and Employment (cont'd)
• Summing up the economic implications of
outsourcing (cont’d)
– Outsourcing is a two-way street
– Labor outsourcing does not just involve U.S.
firms purchasing the labor services of residents
located abroad
– This phenomenon also entails the purchase of
labor services from U.S. workers who provide
outsourcing services to companies located in
other nations
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Labor Outsourcing, Wages,
and Employment (cont'd)
• Summing up the economic implications of
outsourcing (cont’d)
– Not all workers gain equally from the trade of
outsourced labor services, and some people
temporarily lose, in the form of either lower
wages or reduced employment opportunities
– Nevertheless, specialization and trade of labor
services through outsourcing generate overall
gains from trade for participating nations, such
as India, Canada, and the United States
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Why Not … prohibit U.S. firms from
outsourcing?
• Barring U.S. companies from engaging in
international labor outsourcing likely would have
two negative consequences for the U.S. economy:
– The equilibrium wages that U.S. firms would have to pay
to obtain labor that they had previously outsourced
would increase, which would boost their operating costs
and thus the equilibrium prices for consumers.
– Other nations’ governments probably would respond by
prohibiting their own companies from outsourcing to U.S.
workers, resulting in a decrease in the demand for U.S.
labor.
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Monopoly in the Product Market
• Now, let’s assume that the firm sells its product in
an imperfectly competitive market (we assume
the firm purchases inputs under perfect
competition still)
• In other words, we are considering output market
structures of monopoly, oligopoly, and
monopolistic competition
• For the remainder of the chapter, we simply refer
to a monopoly situation for ease of analysis
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Monopoly in the
Product Market (cont'd)
• Constructing the monopolist’s input
demand curve
– In reconstructing the demand schedule for an
input, we must recognize that
• The marginal physical product falls because
of the law of diminishing marginal product
as more workers are added
• The price (and marginal revenue) received for the
product sold also falls as more is produced and sold
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Figure 28-7 A Monopolist’s Marginal
Revenue Product, Panel (a)
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Figure 28-7 A Monopolist’s Marginal
Revenue Product, Panel (b)
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Monopoly in the
Product Market (cont'd)
• Question
– Why does the monopolist hire fewer workers?
• Answer
– The marginal benefit to the monopolist of
hiring
an additional worker is affected by the fact that
the monopolist faces a reduction in the price
charged on all units in order to be able to sell
more of the product
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The Utilization of
Other Factors of Production (cont'd)
• Cost minimization
– To minimize total costs for a particular rate of
production, the firm will hire factors of
production up to the point at which the
marginal physical product per last dollar spent
on each factor is equalized
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28-46
The Utilization of Other Factors of
Production (cont'd)
• Cost minimization
MPP of labor
Price of labor
=
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MPP of capital
Price of capital
=
MPP of land
Price of land
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Policy Example: Payroll Regulations Spur
the Hiring of Independent Contractors
• Recently, U.S. firms have been hiring more
independent contractors relative to the number of
full-time employees.
• The key reason is that the federal government
has gradually been requiring firms to provide
more benefits—overtime pay, family leave, and
health benefits—for full-time employees.
• The resulting higher effective wage rate for fulltime employees has push down their MMP/wage
rate ratio relative to the ratio for independent
contractors.
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The Utilization of
Other Factors of Production (cont’d)
• Profit maximization revisited
– MRP of labor = Price of labor (wage)
– MRP of land = Price of land (rent)
– MRP of capital = Price of capital (cost per unit
of service)
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You Are There: At Staples, the Demand for
Robotic Inputs Is Increasing
• Warehouses operated by Staples, the office
supply retailer, have used robots called the “Kiva
bot” to transport items and work alongside
human workers.
• Robotic technology has become more useful for
smaller and smaller tasks that were previously
performed only by humans.
• What will happen to the demand for human
warehouse workers at Staples?
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Issues & Applications: The Incentives to
Outsource Labor Internationally
• What affects a firm’s decision regarding
international labor outsourcing?
– The workers’ constant-quality marginal physical product
in different countries
– The distance between a firm’s location and the
outsourced labor that it hires: the greater the distance,
the more miscommunications and other problems
– Wages
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Figure 28-8 Average Hourly Wages of CallCenter Agents in Selected Nations
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Summary Discussion
of Learning Objectives
• Why a firm’s marginal revenue product
curve is its labor demand curve
– In competitive markets, firms hire labor to the
point at which the wage equals MRP
• The demand for labor as a “derived
demand”
– The demand for labor by perfectly competitive
firms is derived from the demand for the final
products they produce
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28-53
Summary Discussion
of Learning Objectives (cont'd)
• Key factors affecting the elasticity of
demand for inputs
– Price elasticity of demand for the
final product
– Ease of substitution of other inputs
– Proportion of total costs
– Time period
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28-54
Summary Discussion
of Learning Objectives (cont'd)
• How equilibrium wage rates at perfectly
competitive firms are determined
– The wage at which the quantity of labor
supplied by all workers equals the quantity of
labor demanded by all firms
• U.S. wage and employment effects of
labor outsourcing
– Decreased demand for U.S. workers when
cheaper labor is available overseas
– Increased demand for some U.S. labor
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28-55
Summary Discussion
of Learning Objectives (cont'd)
• Contrasting the demand for labor and
wage determination under monopoly with
outcomes under perfect competition
– A monopolist’s labor demand curve is to the
left of that of a perfectly competitive industry.
– Marginal revenue for a monopolist is less
than price.
– Fewer workers are employed by the
monopolist.
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