Transcript The Labor Market

CHAPTER
9
The Labor Market
Prepared by: Jamal Husein
© 2005 Prentice Hall Business Publishing
Survey of Economics, 2/e
O’Sullivan & Sheffrin
The Labor Market


The model of supply and demand can
be used to study the determination of
wages & employment in the labor
market.
Topics in this chapter include:



The determination of wages in a perfectly
competitive market
An explanation of why wages differ from
one occupation to another
The effects of labor market imperfections
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A Perfectly Competitive Input Market

A perfectly competitive firm:

Takes the prices of its inputs as
given (price taker in the input
market);

Is one of so many hiring firms
in the market;
Can hire as many workers as it
wants as long as it pays the
market wage rate.

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Diminishing Returns and the Optimal
Quantity of Labor

The firm uses the marginal principle to decide
how many workers to hire.
Marginal PRINCIPLE
Increase the level of an activity if its marginal benefit
exceeds its marginal cost, but reduce the level if the
marginal cost exceeds the marginal benefit. If
possible, pick the level at which the marginal benefit
equals the marginal cost.

The firm will pick the quantity of labor at which
the marginal benefit of labor equals the marginal
cost of labor.
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The Marginal Cost of Labor

The marginal cost of
labor is simply the
hourly wage in the
market, or the extra
cost associated with one
more hour of labor.

The marginal cost
curve is also the
labor-supply curve
faced by the firm.
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When the wage is $8 an hour,
the firm can hire 3, 5 or any
number of workers at that
wage.
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The Marginal Benefit of Labor

The marginal benefit of labor equals the
monetary value of the output produced with
an additional hour of labor.

The marginal benefit of labor is called
marginal revenue product (MRP), or
the extra revenue generated by one
additional worker.
MRP = price of output × marginal product
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The Firm Faces Diminishing Returns
in the Short Run

In the short run, the firm is subject to
diminishing marginal returns from labor. The
change in output from one additional worker
decreases as the number of workers increases.
PRINCIPLE of Diminishing Returns
Suppose that output is produced with two or more
inputs and that we increase one input while holding
the other inputs fixed. Beyond some point—called
the point of diminishing returns—output will increase
at a decreasing rate.
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Marginal Benefit and Diminishing
Returns

Because the firm faces
diminishing returns in
the short run, the
marginal product of
labor decreases with
additional workers
hired.

In other words, there is
a negative relationship
between the number of
workers hired and
marginal revenue
product.
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
The MRP curve (or marginal
benefit) is also the firm’s
short-run demand curve for
labor.
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The Marginal Benefit (Demand) and the
Marginal Cost (Supply) of Labor
The Marginal Principle for Labor Decision
Number
of
workers
Balls
per hour
Marginal
product
Price
Per
Ball
Marginal
Benefit =
MRP
Profit
(Total
Approach
Marginal
Cost =
Wage
1
26
26
$0.5
$13
$5,090
$8
2
50
24
$0.5
$12
$5,760
$8
3
72
22
$0.5
$11
$6,165
$8
4
92
20
$0.5
$10
$6,300
$8
5
108
16
$0.5
$8
$6,165
$8
6
120
12
$0.5
$6
$5,740
$8
7
128
8
$0.5
$4
$5,000
$8
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How Many Workers Will the Firm Hire?
At an hourly wage of $8, how many workers should
the firm hire? Why?
Marginal Benefit or marginal cost ($)

Marginal revenue product
equals marginal cost when the
firm hires five workers.
n
11
m
8
Marginal cost when Wage=$8
t
6
Marginal Revenue Product or
marginal benefit curve
3
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Number of workers
6
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How Many Workers Will the Firm Hire?
Marginal Benefit or marginal cost ($)

At $8 an hour, the firm hires 5 workers. If the wage goes
up to $11 an hour, how many workers should the firm
hire? Why?
Marginal revenue product equals
marginal cost when the firm hires
three workers.
n
11
Marginal cost when Wage=$11
m
8
Marginal cost when Wage=$8
t
6
Marginal Revenue Product or
marginal benefit curve
3
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Number of workers
6
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Shifts in the Demand for Labor Curve


To draw the labor
demand curve, we
hold fixed the price
of the output and
the productivity of
workers.
An increase in the
price of the output
or in productivity
will shift the labor
demand curve to
the right.
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
At each wage, the firm
will hire more workers.
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The SR Market Demand for Labor

The short-run market demand curve for
labor is the sum of the labor demands of
all the firms that use a particular type of
labor.
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Labor Demand in the Long Run

The long-run labor demand
curve shows the relationship
between the wage and the
quantity of labor demanded over
the long run, when the number
of firms and the size of their
production facilities can change.
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Labor Demand in the Long Run

Although there are no diminishing returns in the
long run, the long-run labor demand curve is still
negatively sloped for two reasons:

The output effect: higher wages mean higher
production costs, higher prices, lower quantity
demanded, lower output sold; therefore, less
need for inputs

The input-substitution effect: higher wages
will cause the firm to substitute other inputs for
labor; the firm will use more machinery and
fewer workers
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Short-run Versus Long-run Labor
Demand

The demand for labor is less elastic (steeper) in the shortrun than in the long run (flatter), because in the short run
the firm has less flexibility to substitute other inputs for
labor or modify its production facilities.

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A decrease in wages,
for example, results
in a larger number of
workers hired in the
long run, after firms
have a chance to
make their facilities
more labor-intensive.
16
The Supply of Labor

The labor supply curve shows
the amount of labor hours that
will be supplied at each wage,
for a specific occupation, in a
specific geographical area.
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The Individual Decision: How Many
Hours?

The decision to work is based on the principle
of opportunity cost.
PRINCIPLE of Opportunity Cost
The opportunity cost of something is what you
sacrifice to get it.

The decision to work is a decision to sacrifice
leisure, and vice versa. In other words, the
opportunity cost of leisure is the income
sacrificed for each hour of leisure, or the
hourly wage.
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The Demand for Leisure

An increase in the wage—the price
of labor—has the following effects
on the demand for leisure:
 Substitution effect: as the wage
increases, a worker will substitute
income for leisure time

Income effect: an increase in the
wage increases the worker’s real
income and the demand for leisure
time
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The Demand for Leisure

The substitution and income effects of a
higher wage move in opposite directions:
The substitution effect increases the
desired leisure time
 The income effect decreases the
desired leisure time


Therefore, we can’t predict if a higher wage
will increase or decrease the preference for
leisure, and consequently the supply of
labor.
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The Demand for Leisure


There are three possible responses to a
higher wage:
 A decrease in hours worked while income
remains the same
 No change in hours worked, while income
increases and leisure remains the same
 An increase in hours worked, while
income increases and leisure decreases
Studies show that in most labor markets,
increases in hours worked nearly offset
decreases.
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The Market Supply Curve


The market supply
curve for labor
shows the
relationship
between the wage
and the quantity of
labor supplied.
The positive slope of the labor supply curve is
consistent with the law of supply. The higher the
wage, the larger the quantity of labor supplied.
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Reasons for the Positive Slope of the
Labor Supply Curve

An increase in the wage affects the
quantity of labor supplied in three ways:
1. An increase in hours worked per worker
2. Occupational choice: a higher wage will
attract workers to that occupation
3. Migration: people will move to the city
where wages in a given occupation are higher

The first effect is uncertain, but the second
and third effects carry sufficient weight to
make the supply curve positively sloped.
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Market Equilibrium
Hourly Wage ($)

Equilibrium in the labor market exists when
there is no pressure for the wage to change.
Changes in demand and supply will affect
market equilibrium.
Market Supply
curve
e
20
b
c
13
Market demand curve
8,000
16,000 24,000
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Hours of nursing per day
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Market Equilibrium

Equilibrium in the labor market exists when
there is no pressure for the wage to change.
Changes in demand and supply will affect
market equilibrium.
Hourly Wage ($)

f
22
Market Supply
curve
e
20
In this example, an
increase in demand
increases the wage
and the quantity of
nursing services.
New demand curve
Market demand curve
16,000 19,000
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Hours of nursing per day
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Explaining Differences in Wage and
Income

When the supply of workers is small relative to the
demand for those workers, the wage will be high.
Hourly
Wage ($)
Supply with
few workers
Market
Supply
curve
f
30

e
20
Market
demand
curve
8,000
16,000
Hours of nursing per day
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Supply could be small for
four reasons:
 Few people have the
required skills
 There are high training
costs involved
 Undesirable job features
 Artificial barriers to
entry
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Gender Discrimination

Studies about the gender gap have
found that:


Women in many occupations have less
education, less work experience, thus are
less productive and are paid less.
Access denied to many occupations has
caused women to flood certain other
occupations. To close the gender gap,
women would have to change
occupations.
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Race Discrimination

Studies about the gender gap have found that:
 In 1995, black males earned 73% as much as their
white counterparts.
 Hispanic males earned 62% as much as white
males. Hispanic females eared 73% as much as
white females.
 Discrimination decreases the wages of black men
by about 13%.
 Part of the earnings gap is due to productivity
differences and part is due to racial
discrimination, but in the 1990s, most disparities
were due to differences in skills, not
discrimination.
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Why Do College Graduates Earn
Higher Wages?

In 2001, the typical graduate earned 76% more
than the typical high-school graduate. Here are
two reasons why:

The learning effect: college students learn the skills
required for certain occupations for which there is a
smaller supply of workers

The signaling effect: a person who completes a college
degree sends a signal to the employers that some of the
skills required to complete a degree are the same skills
required at work (time management, ability to learn,
etc.)
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Public Policy and Labor Markets:
Effects of the Minimum Wage

The minimum wage decreases the quantity of labor employed
and yields good news and bad news for workers and employers:


51
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Good news: some
workers keep their jobs
and earn a higher wage.
Bad news: some workers
lose their jobs, and
production costs rise,
increasing the price of
goods and services.
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Public Policy and Labor Markets:
Occupational Licensing

Government-sanctioned licensing
boards require a person to:



Complete an educational program.
Pass an examination.
Have a certain amount of work
experience.
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Public Policy and Labor Markets:
Occupational Licensing

Occupational licensing has been criticized on three
grounds:
1.
Weak link between
performance and licensing
requirements
2.
Alternative means of
protection from
incompetent workers
3.
Restrictions that increase
the cost of entry result in a
decrease in the supply of
workers, and an increase
the wages paid
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Labor Unions

A labor union is an organized group of
workers who generally pursue the
following objectives:




To increase job security
To improve working conditions
To increase wages and fringe benefits
There are two types of labor unions:


Craft unions
Industrial unions
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Unionization Rates in the United States
Percent of workers that are union members
Unionization Rates in the United States, 1997
37.2
40
35
30
25
20
14.1
15
9.7
10
5
0
All wage & salary
workers
Public sector workers
Private sector workers
Statistical Abstract of the United States, 1998
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Important Pieces of Labor Legislation
1935
The Wagner Act guaranteed workers the right to join unions and
required each firm to bargain with a union formed by a majority
of its workers. The National Labor Relations Act was established
to enforce the provisions of the Wagner Act.
1947
The Taft-Harley Act gave government the power to stop strikes
that “imperiled the national health or safety” and gave the states
the right to pass “right-to-work” laws. Right-to-work laws
outlaw union membership as a precondition of employment.
1959
The Landrum-Griffin Act was a response to allegations of
corruption and misconduct by union officials. This act
guaranteed union members the right to fair elections, made it
easier to monitor union finances, and made the theft of union
funds a federal offense.
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Labor Unions and Wages

Three approaches to increase the wages of
union workers:
1. Organize workers and negotiate a higher
wage—restricting membership
2. Promote the products produced by union
workers; labor demand is derived demand
3. Increase the amount of labor required to
produce a given quantity of output—a
practice known as “featherbedding”
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Imperfect Information in the
Labor Market

There is asymmetric information in the labor
market because employers cannot distinguish
between skillful and unskillful workers, or
between hard workers and lazy workers.

If the employer cannot distinguish between
different types of workers, it will pay a single
wage, realizing that it will probably hire workers
of each type.
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Efficiency Wages

To attract some high-skill workers, the employer
must pay a wage that exceeds the opportunity
cost of high-skill workers.

As the firm attracts more skilled workers, the
average productivity of the workforce rises.

It follows that by paying efficiency wages to
increase the average productivity of its workforce,
a firm could increase its profit.
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