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  1. 1. The Labor Market Chapter 15
  2. 2. Labor Supply <ul><li>The labor supply is the willingness and ability to work specific amounts of time at alternative wage rates in a given time period, ceteris paribus. </li></ul>
  3. 3. Income vs. Leisure <ul><li>The opportunity cost of working is the amount of leisure time that must be given up in the process. </li></ul><ul><li>Higher wage rates are needed to compensate for the increasing opportunity cost of labor. </li></ul><ul><li>The marginal utility of income may decline as you earn more. </li></ul>
  4. 4. Income vs. Leisure <ul><li>The upward slope of an individual’s labor-supply curve is a reflection of two phenomena: </li></ul><ul><ul><li>The increasing opportunity cost of labor as leisure time declines. </li></ul></ul><ul><ul><li>The decreasing marginal utility of income as a person works more hours. </li></ul></ul>
  5. 5. The Supply of Labor People supply more Labor when wages rise w 1 w 2 B A q 1 q 2 Quantity of Labor (hours per week) Wage Rate (dollars per hour) Labor supply 0
  6. 6. A Backward Bend? <ul><li>Higher wages represent more goods and services and thus induce people to substitute labor for leisure. </li></ul><ul><li>Substitution Effect of Wages – An increased wage rate encourages people to work more hours (to substitute labor for leisure). </li></ul>
  7. 7. A Backward Bend? <ul><li>A worker might also respond to higher wage rates by working less, not more. </li></ul><ul><li>Income Effect of Wages – An increased wage rate allows a person to reduce hours worked without losing income. </li></ul>
  8. 8. A Backward Bend? <ul><li>If income effects outweigh substitution effects, an individual will supply less labor at higher wages. </li></ul>
  9. 9. The Backward-Bending Supply Curve Substitution effects dominate Income effects dominate Quantity of Labor Supplied (hours per week) Wage Rate (dollars per hour) 0
  10. 10. Market Supply <ul><li>The market supply of labor is the total quantity of labor that workers are willing and able to supply at alternative wage rates in a given time period, ceteris paribus. </li></ul>
  11. 11. Market Supply <ul><li>The labor supply curve shifts when the determinates of labor supply change: </li></ul><ul><ul><li>Tastes – for leisure, income, and work. </li></ul></ul><ul><ul><li>Income and wealth . </li></ul></ul><ul><ul><li>Expectations – for income or consumption. </li></ul></ul><ul><ul><li>Prices of consumer goods . </li></ul></ul><ul><ul><li>Taxes . </li></ul></ul>
  12. 12. Shifts in Market Supply <ul><li>Over time, the labor supply curve has shifted leftward: </li></ul><ul><ul><li>A rise in living standards. </li></ul></ul><ul><ul><li>Income transfer programs that provide economic security when not working. </li></ul></ul><ul><ul><li>Increased diversity and attractiveness of leisure activities. </li></ul></ul>
  13. 13. Elasticity of Labor Supply <ul><li>We use the concept of elasticity to measure the movements along the labor-supply curve resulting from wage rate changes. </li></ul>
  14. 14. Elasticity of Labor Supply <ul><li>The elasticity of labor supply is the percentage change in the quantity of labor supplied divided by the percentage change in wage rate. </li></ul>
  15. 15. Institutional Constraints <ul><li>A workers responsiveness to wage changes is often constrained by institutional constraints such as specified work hours such as 8 – 5 shifts. </li></ul>
  16. 16. Labor Demand <ul><li>The demand for labor is the quantity of labor employers are willing and able to hire at alternative wage rates in a given time period, ceteris paribus. </li></ul>
  17. 17. Derived Demand <ul><li>The quantity of resources purchased by a business depends on the firm’s expected sales and output. </li></ul><ul><li>It is a derived demand. </li></ul>
  18. 18. Derived Demand <ul><li>Derived demand is the demand for labor and other factors of production resulting from (depending on) the demand for final goods and services produced by these factors. </li></ul>
  19. 19. The Labor-Demand Curve <ul><li>The number of workers hired is not completely dependent upon the demand for the product. </li></ul><ul><li>The quantity of labor demanded also depends on its price (the wage rate). </li></ul>
  20. 20. The Demand for Labor More workers are sought at lower wages Demand for labor 0 L 1 L 2 W 2 W 1 Wage Rate (dollars per hour) Quantity of Labor (hours per month) A B
  21. 21. Marginal Physical Product <ul><li>Marginal physical product ( MPP ) is the change in total output associated with one additional unit of input. </li></ul>
  22. 22. Marginal Revenue Product <ul><li>Marginal revenue product ( MRP ) - the change in total revenue associated with one additional unit of input. </li></ul>MRP = MPP X p
  23. 23. Marginal Revenue Product <ul><li>Marginal revenue product sets an upper limit to the wage rate an employer will pay. </li></ul>
  24. 24. Diminishing MPP <ul><li>The marginal physical product of labor eventually declines as the quantity of labor employed increases. </li></ul>
  25. 25. The Law of Diminishing Returns <ul><li>According to the law of diminishing returns , the marginal physical product of a variable factor declines as more of it is employed with a given quantity of other (fixed) inputs. </li></ul>
  26. 26. The Law of Diminishing Returns
  27. 27. The Law of Diminishing Returns Number of Pickers (per hour) 0 1 2 3 4 5 6 7 8 9 10 0 2 4 6 8 10 12 14 16 18 20 22 Output of Strawberries (boxes per hour) Total output Marginal output (per picker) A B C D E F G H I b c d e f g h i – 4 – 2
  28. 28. Diminishing MRP <ul><li>As marginal physical product diminishes, so does marginal revenue product. </li></ul>
  29. 29. Diminishing MRP
  30. 30. The Hiring Decision <ul><li>Marginal revenue product determines how much labor will be hired. </li></ul>
  31. 31. The Firm’s Labor Supply <ul><li>A firm that is a perfect competitor in the labor market can hire all the labor it wants at the prevailing market wage. </li></ul>
  32. 32. MRP = Firm’s Labor Demand <ul><li>An employer will continue to hire people until the MRP has declined to the level of the market wage rate. </li></ul><ul><li>Each (identical) worker is worth no more than the marginal revenue product of the last worker hired, and all workers are paid the same wage rate. </li></ul>
  33. 33. MRP = Firm’s Labor Demand 0 1 2 3 4 5 6 7 8 9 1 2 3 4 5 6 7 8 9 10 $11 Wage rate MRP A B C MARGINAL REVENUE PRODUCT (dollars per hour) QUANTITY OF LABOR (workers per hour) D
  34. 34. Changes in Wage Rates <ul><li>There is a tradeoff between wages and the number of workers hired. </li></ul><ul><li>If the wage rates go up, fewer workers will be hired. </li></ul>
  35. 35. Incentives to Hire New wage rate Lower wages spur more hires Quantity of Labor Demanded (pickers per hour) Wage Rate (dollars per hour) 0 1 2 3 4 5 6 7 8 9 2 4 6 8 10 $12 MRP = demand Initial wage rate A B C G D
  36. 36. Changes in Productivity <ul><li>To get higher wages without sacrificing jobs, productivity (MRP) must increase. </li></ul><ul><li>Increased productivity implies that workers can get higher wages without sacrificing jobs or more employment without lowering wages. </li></ul>
  37. 37. Incentives to Hire Higher productivity spurs more hires New demand curve D 2 F E Quantity of Labor Demanded (pickers per hour) Wage Rate (dollars per hour) 0 1 2 3 4 5 6 7 8 9 2 4 6 8 10 $12 Initial demand curve Initial wage rate D 1 C
  38. 38. Changes in Price <ul><li>An increase in product price will also increase MRP and thus demand for labor. </li></ul><ul><li>Price changes depend on changes in the market supply and demand for the product being sold. </li></ul>
  39. 39. Market Equilibrium <ul><li>The market demand for labor depends on: </li></ul><ul><ul><li>The number of employers. </li></ul></ul><ul><ul><li>The marginal revenue product of labor in each firm and industry. </li></ul></ul>
  40. 40. Market Equilibrium <ul><li>The market supply of labor depends on: </li></ul><ul><ul><li>The number of workers. </li></ul></ul><ul><ul><li>Each worker’s willingness to work at alternative wage rates. </li></ul></ul>
  41. 41. Equilibrium Wage <ul><li>The intersection of the market supply and demand establishes the equilibrium wage. </li></ul><ul><li>The equilibrium wage is the wage at which the quantity of labor supplied in a given time period equals the quantity of labor demanded. </li></ul>
  42. 42. Equilibrium Wage <ul><li>Competitive employers act like price takers with respect to wages as well as prices. </li></ul>
  43. 43. Equilibrium Wage Labor supply confronting firm w e MRP of firm's labor q 0 Quantity of Labor (workers per time period) A competitive firm Quantity of Labor (workers per time period) Wage Rate (dollars per hour) Market demand Market supply The labor market w e
  44. 44. Minimum Wages <ul><li>A government-imposed minimum wage (wage floor): </li></ul><ul><ul><li>Reduces the quantity of labor demanded. </li></ul></ul><ul><ul><li>Increases the quantity of labor supplied. </li></ul></ul><ul><ul><li>Creates a market surplus. </li></ul></ul>
  45. 45. Minimum Wages <ul><li>The size of the job loss caused by a higher minimum wage depends on labor-market conditions. </li></ul>
  46. 46. Minimum Wages <ul><li>When the minimum wage is below the equilibrium wage, an increase in the minimum may have little or no adverse employment effects. </li></ul>
  47. 47. Minimum Wages <ul><li>The further the minimum wage rises above the market’s equilibrium wage, the greater the job loss. </li></ul>
  48. 48. Minimum Wage Effects Market surplus Labor demand Labor supply Minimum wage Equilibrium wage rate New entrants who can't find jobs E w e q e Workers who keep jobs at higher wage Job losers w m Wage Rate (dollars per hour) 0 Quantity of Labor (hours per year) q d q s
  49. 49. Choosing Among Inputs <ul><li>Employers can use more machinery in place of labor. </li></ul>
  50. 50. Cost Efficiency <ul><li>To determine whether to hire a worker or use a machine, a firm compares the ratio of the marginal physical products to their cost. </li></ul><ul><li>This ratio expresses the cost efficiency of an input. </li></ul>
  51. 51. Cost Efficiency <ul><li>Cost efficiency is the amount of output associated with an additional dollar spent on input – the MPP of a product divided by its price (cost). </li></ul>
  52. 52. Cost Efficiency <ul><li>The most cost-efficient factor is the one that produces the most output per dollar. </li></ul>
  53. 53. Alternative Production Processes <ul><li>Typically a producer does not choose between individual inputs but rather between alternative production processes. </li></ul><ul><ul><li>Production process - A specific combination of resources used to produce a good or service. </li></ul></ul>
  54. 54. Alternative Production Processes
  55. 55. The Efficiency Decision <ul><li>The producer seeks to use the combination of resources that produces a given rate of output for the least cost. </li></ul><ul><ul><li>Efficiency decision - The choice of a production process for any given rate of output. </li></ul></ul>
  56. 57. Capping CEO Pay <ul><li>Critics of CEO pay believe that CEO paychecks are out of line with realities of supply and demand. </li></ul><ul><li>They want corporations to revise the process used for setting CEO pay levels. </li></ul>
  57. 58. Unmeasured MRP <ul><li>One of the difficulties in determining the appropriate level of CEO pay is the elusiveness of marginal revenue product. </li></ul><ul><li>The wage of CEOs is set by their opportunity wage. </li></ul>
  58. 59. Unmeasured MRP <ul><li>The opportunity wage is the highest wage an individual would earn in his or her best alternative job. </li></ul>
  59. 60. Unmeasured MRP <ul><li>If markets work efficiently, such government intervention should not be necessary. </li></ul>
  60. 61. Unmeasured MRP <ul><li>Corporations that pay their CEOs excessively will end up with smaller profits than companies who pay market-based wages. </li></ul>
  61. 62. The Labor Market End of Chapter 15
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