Transcript No Slide Title

Principles of Economics
by Fred M Gottheil
PowerPoint Slides prepared by Ken Long
©1999 South-Western College Publishing
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Chapter 15
Wage Rates in
Competitive Labor
Markets
7/17/2015
©1999 South-Western College Publishing
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Turn from the product market to
the factor (input or resource)
market
Roles of supply and demand are
reversed: firms demand the
factors, people supply them, as in
the labor market
Factor demand is a derived demand,
that is, derived from the demand
for the product being produced. 3
As in product market,
different kinds of factor
markets
Begin with a perfectly competitive
factor market, price of the factor is
determined by supply and demand
for the factor
What is the profit maximizing
quantity of a factor that a firm
should use?
4
Here, we assume a
competitive labor market
• Many buyers and sellers
of labor
• Homogenous labor
• Perfect information and
mobility
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You already know a lot
about the labor market
Use marginal analysis,
hire labor to the point
where the added cost
equals the added revenue
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What is Marginal
Physical Product?
MPP is the change in output
that results from adding one
more unit of resource, such
as labor, to production
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Q
MPP =
L
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What is Marginal
Revenue Product?
MRP is the change in total
revenue that results from
adding one more unit of a
resource, such as labor, to
production
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MRP = MPP x P
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10 0
TR
MRP =
L
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Calculation of MRP
Labor
Output
0
0
1
10
2
MPP
P
TR
MRP
$5
0
10
$5
$50
$50
18
8
$5
$90
$40
3
24
6
$5
$120
$30
4
28
4
$5
$140
$20
5
30
2
$5
$150
$10
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Why is the MRP Curve
downward sloping?
Due to the law of
diminishing returns
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What is the Demand
Curve for Labor?
Same as the Laborer’s
MRP curve
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W1
W2
Q1
Q2
1
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What is
Marginal Labor Cost?
MLC is the change in a
firm’s total cost that results
from adding one more
worker to production
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TLC
MLC =
L
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What is MLC equal to in
a perfectly competitive
labor market?
The same as the market
wage rate, that is,
MLC = W (wage)
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MLC = W1
W1
MRP
Q1
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How many people are
hired to maximize profit?
Up to and including the
point where MRP = W
Why?
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As long as MRP is
greater than the wage
rate, another worker will
be hired because it is
profitable to do so
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Why is profit made from
hiring the last worker if
MRP > W?
Because that last worker
adds more to total
revenue than what that
last worker is paid
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At what point will the
last worker not be hired?
That last worker will not
be hired where MRP < W
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Why will the last worker
not be hired where
MRP < W?
Because the last worker
would cost more than
what that last worker
could add to total
revenue
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Return to the table
showing MRP
calculation
How many workers should
this firm hire if the wage
equals $20?
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Calculation of MRP
Labor
Output
0
0
1
10
2
MPP
P
TR
MRP
$5
0
10
$5
$50
$50
18
8
$5
$90
$40
3
24
6
$5
$120
$30
4
28
4
$5
$140
$20
5
30
2
$5
$150
$10
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Answer: 4 workers,
where MRP = W = $20
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Shifts in the MRP curve, the firms
demand curve for labor, can be
caused by:
Changes in the product
price
Changes in productivity
of labor
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Shift in Demand Curve
W
D2=MRP2
D1=MRP1
Q
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What is a Supply Curve
for labor?
A curve that shows how
many units of labor will
be supplied at various
wages
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Wage
S
W2
W1
Q1
Q2
Labor
Why is the Supply Curve for
Labor generally upward
sloping?
Because as the wage rate
increases, more
workers in the labor
market will accept a job
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Difference between Market supply
of labor and one individual’s labor
supply
An individual’s labor supply curve
might not always slope upward
Depends on the substitution and
income effects of a wage change
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Labor-Leisure trade off
Think of leisure as a product, we
“buy” it by giving up labor, thus
the price of leisure = wage given
up
Thus higher wages raise the price
of leisure, 2 possible effects to this
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Substitution effect: higher wages raise
the price of leisure, thus buy less
leisure, work more
Income effect: higher wages raise
income, thus demand more leisure ( a
normal good), therefore work less
Shape of the Supply curve depends on
strength of these 2, possible backward
bending labor supply curve
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ABOVE W1, INCOME
EFFECT
OUTWEIGHS
SUBSTITUTION
EFFECT, WORK
LESS DUE TO
HIGHER WAGE
Wage
W1
UP TO W1,
SUBSTITUTION
EFFECT OUTWEIGHS
INCOME EFFECT,
WORK MORE DUE TO
HIGHER WAGE
Labor
L1
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What can cause a
shift in the Supply
Curve for Labor?
• Other opportunities
• Non-monetary aspects of a job
• Changes in size of the market
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Shift in Supply
W
S1
S2
Q
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WAGES IN A FREE MARKET
W1
Surplus
S
W3
W2
Shortage
Q3
D
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Wage rate differentials
Suppose wages for the
same type of labor are
higher in the north than
the south, what tends to
happen in the long run?
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Labor tends to migrate north,
decreasing labor supply in the
south and increasing it in the north
Firms tend to migrate south,
increasing labor demand in the
south, decreasing it in the north
Net effect is to reduce the wage
differential
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Check out the Bureau
of the Census at:
http://www.bls.census.gov/cps/
cpsmain.htm
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What happens when the
government imposes a
minimum wage?
The number of workers
demanded is less than the
number of workers
supplied for low wage jobs
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W
The Minimum Wage
Unemployment
S
D
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The Minimum Wage
W
S
wM
D2
D1
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Note that the magnitude of
the effect of the
minimum wage depends
on the elasticity of
demand and supply of
labor
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For more information
on the Minimum Wage:
http://www.dol.gov/dol/esa/pub
lic/minwage/main.htm
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What is the Efficiency
Wage Theory?
A firm may pay a wage
higher than the market’s
equilibrium wage in hopes
of minimizing turnover and
increasing productivity
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Elasticity of Demand for Labor ( or
other factors of production)--depends
on what?
Elasticity of product demand, more elastic
the demand for the product, the more
elastic the demand for factors
Importance in total cost, greater share of total
cost a factor is, more elastic the demand
Ease of substitution--easier to substitute for a
factor, more elastic its demand it
Time period, more elastic demand the longer
the time period
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http://www.acinet.org
http://www.AJB.dni.us
http://www.detnews.com
http://www.state.mi.us/mjc/ceo/
http://www.homefair.com/homefair/
cmr/salcalc.html
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•
•
•
•
What is Marginal Physical Product?
What is Marginal Revenue Product?
What is Marginal Labor Cost?
What is the Law of Diminishing
Returns?
• Why is the Demand Curve for
Labor negative?
• Why is the Supply Curve for Labor
upward sloping?
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END
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