Transcript Principles of Economics Third Edition by Fred Gottheil

Chapter 15
Wage Rates in
Competitive Labor Markets
© 2005 Thomson
Economic Principles
Marginal physical product of
labor
Marginal revenue product
The law of diminishing returns
Marginal labor cost
The profit-maximizing level
of employment
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Economic Principles
Firm and industry demand for
labor
The supply of labor
The backward-bending supply
curve of labor
Wage differentials
Minimum wage laws
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You Load Sixteen Tons and
What Do You Get?
Marginal physical product (MPP)
• The change in output that results from
adding one more unit of a resource, such as
labor, to production. MPP is expressed in
physical units, such as tons of coal, bushels
of wheat, or number of automobiles.
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You Load Sixteen Tons and
What Do You Get?
Marginal physical product (MPP)
• MPP = change in output (Q) divided by
change in the number of people employed (L).
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You Load Sixteen Tons and
What Do You Get?
Marginal physical product (MPP)
• Any change in MPP is attributed to the
hiring of one additional employee.
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EXHIBIT 1A OUTPUT AND MARGINAL PHYSICAL
PRODUCT CURVES
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EXHIBIT 1B OUTPUT AND MARGINAL PHYSICAL
PRODUCT CURVES
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Exhibit 1: Output and Marginal
Physical Product Curves
1. How can the shape of the total
output curve in panel a of Exhibit 1
be described?
• The total output curve is upward sloping,
increasing by large amounts until three
miners are employed, then increasing by
smaller and smaller amounts when more
than three miners are employed.
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Exhibit 1: Output and Marginal
Physical Product Curves
2. Why does the MPP curve in panel
b climb to a peak and then fall?
• The MPP curve maps the increases noted
in the total output curve. The MPP
increases for the first three miners, then
falls as more miners are added to
production.
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You Load Sixteen Tons and What
Do You Get?
Law of diminishing returns
• As more and more units of one factor of
production are added to the production
process while other factors remain
unchanged, output will increase, but by
smaller and smaller increments.
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You Load Sixteen Tons and What
Do You Get?
Law of diminishing returns
• Adding more labor to a given stock of
physical capital must eventually create a
less-than-efficient match of labor to capital.
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You Load Sixteen Tons and What
Do You Get?
Law of diminishing returns
• The law is demonstrated in the eventual
flattening of the total output curve and the
negative slope of the MPP curve.
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You Load Sixteen Tons and What
Do You Get?
Marginal revenue product (MRP)
• The change in total revenue that results
from adding one more unit of a resource,
such as labor, to production. MRP, which is
expressed in dollars, is equal to MPP
multiplied by the price of the good.
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You Load Sixteen Tons and What
Do You Get?
Marginal revenue product
• MRP = MPP × price
or
• MRP = change in total revenue (TR)
divided by change in labor (L).
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Deriving the Firm’s Demand
for Labor
The quantity of labor demanded
depends on price. If the price of
labor falls, the quantity
demanded of labor increases.
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Deriving the Firm’s Demand
for Labor
Wage rate
• The price of labor. Typically, the wage
rate is calculated in dollars per hour.
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Deriving the Firm’s Demand
for Labor
Total labor cost (TLC)
• Quantity of labor employed (L) multiplied
by the wage rate (W).
• TLC = L × W
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Deriving the Firm’s Demand
for Labor
Marginal labor cost (MLC)
• The change in a firm’s total cost that
results from adding one more worker to
production.
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Deriving the Firm’s Demand
for Labor
Marginal labor cost (MLC)
• MLC = change in TLC divided by change
in L.
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EXHIBIT 2A DERIVING THE MARGINAL LABOR COST
CURVE
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EXHIBIT 2B DERIVING THE MARGINAL LABOR COST
CURVE
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Exhibit 2: Deriving the
Marginal Labor Cost Curve
What causes the MLC curve to
be horizontal in panel b of
Exhibit 2?
• The labor market is perfectly competitive.
Individual firms cannot influence the wage
rate. The firm can hire as many workers as it
wants at the prevailing wage rate. MLC
is equal to the wage rate.
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Deriving the Firm’s Demand for
Labor
The hiring rule for firms:
• Compare marginal revenue product and
wage rate and hire laborers until MRP = W.
• If MRP > W, hire more laborers.
• If MRP < W, don’t hire.
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EXHIBIT 3
THE DEMAND FOR LABOR
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Exhibit 3: The Demand for Labor
Why is a firm’s demand for labor
equal to marginal revenue
product (MRP)?
• MRP reflects the maximum a firm is willing
to pay for an additional unit of labor.
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Exhibit 3: The Demand for Labor
Why is a firm’s demand for labor
equal to marginal revenue
product (MRP)?
• When the price of labor falls, firms can
afford to hire more labor, even though
MRP declines.
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Deriving the Firm’s Demand
for Labor
Changes in the price of a good
and improvements in technology
shift the demand curve for labor
to the right.
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EXHIBIT 4
SHIFT IN THEA DEMAND CURVE FOR LABOR
CAUSED BY AN INCREASE IN THE PRICE OF
THE GOOD
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Exhibit 4: Shift in the Demand
Curve for Labor Caused by an
Increase in the Price of the Good
How does an increase in the price of
coal affect the number of miners
hired at a wage rate of $24?
• When the price of coal is $2, seven miners
are hired at a wage rate of $24.
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Exhibit 4: Shift in the Demand
Curve for Labor Caused by an
Increase in the Price of the Good
How does an increase in the price
of coal affect the number of miners
hired at a wage rate of $24?
• When the price of coal increases to $3, the
demand curve for miners shifts to the
right.
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Exhibit 4: Shift in the Demand
Curve for Labor Caused by an
Increase in the Price of the Good
How does an increase in the price of
coal affect the number of miners
hired at a wage rate of $24?
• At the new coal price, nine miners are
demanded at the wage rate of $24.
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EXHIBIT 5
THE DERIVATION OF MRP USING OLD AND
NEW TECHNOLOGY (PRICE OF COAL = $2)
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Exhibit 5: The Derivation of MRP
Using Old and New Technology
(Price of Coal = $2)
How does a change from old
technology to new technology affect
the MPP and MRP in Exhibit 5?
• With new technology the same miner is
able to produce twice as much coal.
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Exhibit 5: The Derivation of MRP
Using Old and New Technology
(Price of Coal = $2)
How does a change from old
technology to new technology affect
the MPP and MRP in Exhibit 5?
• The new technology doubles both MPP
and MRP.
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Industry Demand for Labor
If all of the firms in an industry have
essentially the same quality resources,
use the same technology, and compete
for the same laborers in the same labor
market, then the industry’s demand
curve for labor is the same as the
individual firm’s demand curve for
labor, magnified by the number of
firms in the industry.
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EXHIBIT 6
INDUSTRY DEMAND FOR LABOR
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Exhibit 6: Industry Demand
for Labor
What is the firm’s demand for
labor at a wage rate of $20
compared to the industry’s demand
for labor at the same wage rate?
• The firm’s demand for labor is 8 at a
wage rate of $20.
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Exhibit 6: Industry Demand
for Labor
What is the firm’s demand for
labor at a wage rate of $20
compared to the industry’s demand
for labor at the same wage rate?
• With 1,000 firms in the industry, the
industry’s demand for labor at $20 =
(8 × 1,000) = 8,000 laborers.
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The Supply of Labor
The opportunity cost of working
—the value a laborer places on the
next best alternative to working—
is different for different people.
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The Supply of Labor
Opportunity cost determines how
many people are willing to work
at differing wage rates.
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EXHIBIT 7
THE SUPPLY CURVE OF LABOR
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Exhibit 7: The Supply Curve
of Labor
Why does the labor supply curve
slope up in Exhibit 7?
• The curve is upward sloping because the
higher the wage rate, the more willing are
workers to supply greater quantities of
labor. Their opportunity costs are met at
higher wage rates.
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The Supply of Labor
Three factors affect workers’
willingness to supply their labor at
different wage rates: changes in
alternative employment
opportunities, changes in population
size, and changes in wealth.
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The Supply of Labor: Changes
in Alternative Employment
Opportunities
• When new industries willing to
pay higher wage rates enter a
market, fewer laborers are willing
to work for the older industry at the
lower wage rate.
• The supply curve for labor in the
older industry shifts to the left.
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The Supply of Labor: Changes
in Population Size
• When the population of a region
declines, the number of workers
willing to work at any wage rate
declines.
• The supply curve for labor shifts
to the left.
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The Supply of Labor:
Changes in Wealth
• When people have more wealth,
they choose more leisure time and
less work.
• The supply curve for labor shifts
to the left.
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EXHIBIT 8
CHANGES IN THE SUPPLY CURVE OF
LABOR
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Exhibit 8: Changes in the
Supply Curve of Labor
What happens to the quantity of
labor supplied at a wage rate of
$20 when the supply curve shifts
from S to S ?
1
• The quantity of labor supplied drops
from 8,000 to 6,000.
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The Supply of Labor
An increase in the wage rate
typically induces workers to
increase the quantity of labor
supplied, but only up to a certain
point.
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The Supply of Labor
After that point, an increase in
the wage rate results in less, not
more, labor supplied.
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EXHIBIT 9
THE BACKWARD-BENDING SUPPLY CURVE
OF LABOR
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Exhibit 9: The Backward-Bending
Supply Curve of Labor
What is the wage rate at which
the laborer in Exhibit 9 decides
to cut back on the quantity of
labor he is willing to supply?
• The laborer is willing to increase the
quantity of labor supplied up to a wage
rate of $40.
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Exhibit 9: The Backward-Bending
Supply Curve of Labor
What is the wage rate at which
the laborer in Exhibit 9 decides
to cut back on the quantity of
labor he is willing to supply?
• Above $40, the laborer cuts back on
hours worked per week and gains more
leisure time.
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Exhibit 9: The Backward-Bending
Supply Curve of Labor
What is the wage rate at which
the laborer in Exhibit 9 decides
to cut back on the quantity of
labor he is willing to supply?
• To the laborer, the value of the leisure time
is greater than the extra income he could
have earned by working more hours.
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Deriving Equilibrium
Wage Rates
Combining the industry demand
curve for labor and the industry
supply curve for labor allows the
industry equilibrium wage rate
to be derived.
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Deriving Equilibrium
Wage Rates
• Individual firms within the
industry have no influence on the
market wage rate.
• Firms must accept the market
wage rate and face a horizontal
supply curve for labor.
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EXHIBIT 10 THE LABOR MARKET
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Exhibit 10: The Labor Market
How is the level of the horizontal
labor supply curve for the firm in
panel b of Exhibit 10 determined?
• The level of the labor supply curve is
equal to the equilibrium wage rate of the
industry (W = $20).
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Explaining Wage Rate
Differentials
How different opportunity costs of
laborers affect the supply curve of
labor and how differences in
technology and the price of goods
produced by labor affect MRP help
explain why different wage rates exist
in different labor markets.
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EXHIBIT 11
NORTH-SOUTH WAGE RATE
DIFFERENTIALS
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Exhibit 11: North-South Wage
Rate Differentials
What are the factors that caused
the wage rate to decline in the
North in Exhibit 11?
• Immigration from the South to the
North increased the pool of laborers and
thus shifted the North’s labor supply
curve to the right.
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Exhibit 11: North-South Wage
Rate Differentials
What are the factors that caused
the wage rate to decline in the
North in Exhibit 11?
• At the same time, relocation of factories
from the North to the South shifted the
North’s demand curve for labor to the left.
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Exhibit 11: North-South Wage
Rate Differentials
What are the factors that caused
the wage rate to decline in the
North in Exhibit 11?
• An increase in the supply of labor and a
decrease in the demand for labor caused
the wage rate to decline in the North.
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EXHIBIT 12 NET DOMESTIC MIGRATION AND
IMMIGRATION FOR THE NORTHEAST,
MIDWEST, SOUTH, AND WEST: 1998–99
(1,000s OF POPULATION)
Source: Bureau of the Census, Statistical Abstract of the United States, 2001 (Washington, D.C.: U.S. Department of Commerce, 2001), p. 28.
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Exhibit 12: Net Domestic Migration
and Immigration for the Northeast,
Midwest, South, and West: 1998-99
Based on Exhibit 12, which region
of the country experienced the
greatest net total migration?
• The South experienced the greatest net
total migration, with the West a distant
second.
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Explaining Wage Rate
Differentials
The supply curve of labor is
affected not only by the supply
conditions in the labor market,
but also by the government’s
immigration policy.
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Persisting Wage Differentials
Noncompeting labor markets
• Markets whose requirement for specific
skills necessarily excludes workers who do
not have the required skills.
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Persisting Wage Differentials
Specific talents, limited to small
numbers of people, create unique
labor markets that allow relatively
high wage rates and protect wage
rates against erosion.
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The Economics of
Minimum Wage Rates
The problem with persistent wage
differentials is not so much that a
few people make millions, but that
some people are unable to compete
successfully in any occupation that
provides an adequate standard of
living.
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The Economics of
Minimum Wage Rates
In an effort to remedy the
problem, government can outlaw
low wage rates by implementing a
minimum wage law.
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The Economics of
Minimum Wage Rates
• The problem with mandated
minimum wage rates is that employers
cannot be expected to hire workers
whose MRP is below the legislated
minimum wage rate.
• Thus some workers are left with no
job at all.
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The Economics of
Minimum Wage Rates
The impact of minimum-wage
legislation on low-wage-rateearning people depends on the
price elasticities of demand and
supply for labor.
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EXHIBIT 13 THE EFFECTS OF MINIMUM WAGE RATES
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Exhibit 13: The Effects of
Minimum Wage Rates
1. How many people lose their job
when minimum wage rates are
implemented under the price
elasticities of supply and demand
for labor in panel a?
• 1,000 workers were employed at $3
per hour.
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Exhibit 13: The Effects of
Minimum Wage Rates
1. How many people lose their job
when minimum wage rates are
implemented under the price
elasticities of supply and demand
for labor in panel a?
• Only 300 workers are employed at
$5.15. Thus 700 workers lose their jobs.
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Exhibit 13: The Effects of
Minimum Wage Rates
2. How many people lose their job
when minimum wage rates are
implemented under the price
elasticities of supply and demand
for labor in panel b?
• 1,000 laborers were employed at $3
per hour.
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Exhibit 13: The Effects of
Minimum Wage Rates
2. How many people lose their job
when minimum wage rates are
implemented under the price
elasticities of supply and demand
for labor in panel b?
• 9,000 laborers are employed at $5.15
per hour. Thus only 100 lose their job.
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The Ethics of w = MRP
• Most economists accept marketdetermined wage rates as
ethically defensible.
• The ethic is expressed as “From
each according to his or her
contribution, to each according to
his or her contribution.”
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The Efficiency Wages Theory
Efficiency wages
• A wage higher than the market’s
equilibrium rate; a firm will pay this wage
in the expectation that the higher wage will
reduce the firm’s labor turnover and
increase labor productivity.
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The Efficiency Wages Theory
There are several reasons why a firm
may choose to pay efficiency wages:
• Efficiency wages increase workers’ morale
and motivation on the job.
• Efficiency wages allow the firm to select
more qualified workers.
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The Efficiency Wages Theory
There are several reasons why a firm
may choose to pay efficiency wages:
• Reduce labor turnover.
• Deter workers from joining unions.
• Fairness—if the firm is making a profit, it
should share some with its workforce.
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