Factor market: Labor

1. There a two situations we are going to analyze Labor Markets:
1. Perfect Competition for a Good AND for the Labor to produce that good.
2. Imperfect Competition for a Good AND for the Labor to produce that good
We are going to look at Number 1 in this lesson.

2. “Perfectly Competitive Market for (1) the Product and (2) Labor
In a Perfectly Competitive Market for a Good the Price the firm receives is Constant
1. It can SELL all it produces for that constant price
2. The price is set in the Market for the good and the firm is a Price-Taker
3. The DEMAND for its good is Perfectly Elastic (horizontal)—the Firm can sell as
much as it can at the Market Price.
In a Perfectly Competitive Market for Labor the Price the Firm PAYS for Labor is Constant
1. It can HIRE (“buy”) all the workers it needs at a Constant Wage
2. The wage is set in the Market for Labor and the firm is a Wage-Taker
a. Think Fast Food workers.
3. The SUPPLY of labor is Perfectly Elastic (horizontal)—the Labor market SUPPLIES
all the workers the firm needs at the Market Wage
Labor is an INPUT that goes into the Production of an OUTPUT. Labor is a function/Factor of Production.
The DEMAND for an input like Labor is dependent on the DEMAND FOR THE OUTPUT (good/service)
So, the Demand for a factor like labor is called DERIVED DEMAND.

3. “Perfectly Competitive Market for (1) the Product and (2) Labor
(Table from Welkernomics)
Vocabulary:
1. Quantity of Labor (L)---the number of workers a firm could hire
2. Total Product (TP)---How much ALL workers contribute to Production
3. Marginal Product of Labor( MPL)---How much EACH worker contributes to the running total
4. Price of the Product (P)---In a Perfectly Competitive Market the Firm is a PRICE TAKER—Price Constant!
5. Marginal REVENUE Product of Labor (MRPL)---The dollar value of EACH WORKER Marginal Product.
MPL X P = MPL
Marginal Revenue Product of Labor (MRPL) is the same of Value Marginal Product of Labor (VMPL)

4. Firm Labor
MRPL
(W)
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
(Table from Welkernomics)
And so it begins…We first want to plot our
MRPL values. These values ALSO represent
Potential wages (“W”) an employer MIGHT be
Willing to pay a worker based on their PRODUCTIVITY and
The PRICE OF THE GOOD (more on that later)

5. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
(Table from Welkernomics)
MRPL
(W)

6. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
(Table from Welkernomics)
MRPL
(W)

7. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
(Table from Welkernomics)
MRPL
(W)

8. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
(Table from Welkernomics)
MRPL
(W)

9. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
(Table from Welkernomics)
MRPL
(W)

10. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
(Table from Welkernomics)
MRPL
(W)

11. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
(Table from Welkernomics)
MRPL
(W)

12. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
D* for Labor “D L”
Our DEMAND CURVE for Labor
Determined by the MRPL for each worker
(Table from Welkernomics)
MRPL
(W)

13. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
D* for Labor “D L”
Getting a little ahead of myself, but if
the Wage Rate (determined in the
Market for Labor—we will get to that)
is $6.00 per hour, HOW MANY
WORKERS WILL IT HIRE? (hint: look at
the Marginal Revenue Product of
Labor column)
(Table from Welkernomics)
MRPL
(W)

14. Firm Labor
MRPL
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
D* for Labor “D L”
It will hire 6 workers…WHY?
The Profit Maximization Rule of Resource Employment
Marginal Resource Cost (MRC, aka Wage (w) = Marginal Revenue Product of Labor (MRPL)
MRC (w) = MRPL
(Table from Welkernomics)

15. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
D* for Labor “D L”
(Table from Welkernomics)
It won’t want to pay $6.00 per hour to the
5th Worker, because that worker only contributes
$4.00 to Revenues. He/She costs more than he/she
brings in!
NO!!!
MRPL
(W)
“A”

16. Firm Labor
Quantity of Labor
$12
$10
$8
$6
$4
$2
$0
$-2
1 2 3 4 5 6 7 8
D* for Labor “D L”
(Table from Welkernomics)
You WANT to hire workers 1,2, and 3 FOR SURE
Because each of them produces revenue GREATER
than what the Firm pays them.
The Firm hires that 4th Worker because it will Maximize
Profits even though you pay him = to what he brings in.
HIRE UNTIL:
MRC (W) = MRPL
YES!!
MRPL
(W)
“A”

17. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
Assumption: the Firm is hiring in a “Perfectly Competitive Labor Market”. The firm
Can HIRE as many workers as it wants at the Wage Rate Set in the Market (graph on RIGHT).
In other words the market SUPPLIES workers to the firm at a rate of $6.00 per hour.
IMPORTANT POINT: The LABOR SUPPLY CURVE for the FIRM is Horizontal at the Market set
Wage Rate---The firm SUPPLY CURVE is PERFECTLY ELASTIC!!
“A”

18. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
Assumption: the Firm is hiring in a “Perfectly Competitive Labor Market”. The firm
Can HIRE as many workers as it wants at the Wage Rate Set in the Market (graph on RIGHT).
In other words the market SUPPLIES workers to the firm at a rate of $6.00 per hour.
IMPORTANT POINT: The LABOR SUPPLY CURVE for the FIRM is Horizontal at the Market set
Wage Rate---The firm SUPPLY CURVE is PERFECTLY ELASTIC!!
FIRM LABOR SUPPLY CURVE
“A”

19. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
FIRM LABOR SUPPLY CURVE
GOT THAT!!!! Ok, I will assume you do. Now…We want to divide and conquer.
Let’s isolate the Firm Labor Graph and look at what SHIFTS the Demand/MRPL Curve
Oh, you thought it was going to be easy???

20. SL*
Focus only on the D*=MRPL* curve. The Marginal Revenue Product of Labor was
Calculated by taking Marginal Product (MP) and multiplying it by Price (P). Right?
So, MRPL can change IF: Marginal Product (MP) changes and/or Price (P) changes.
“A”

21. SL*
Let’s start with a change in Marginal Product (MP) and keep it simple. What allows a
Worker to be MORE productive now and in the future?
1. Education/Training/Skills/Processes (efficiencies)
2. Technology/Capital Equipment.
“A”

22. SL*
So, anything that allows a worker to produce MORE than they did before will INCREASE
Their MARGINAL PRODUCT.
***All else equal and the Price of the good does not change then an increase in MP will
INCREASE Marginal Revenue Product of Labor (MRPL)***
“A”

23. Assume the Firm employs additional Capital, provides training to workers, or
in some other way increases the efficiency level to produce.
Assume this allows EACH worker to produce an additional 2 Units of the good each hour.
See the chart above as I add to more units to the Marginal Product, then
Change the Marginal Revenue Product of Labor for each worker.
PRICE X MARGINAL PRODUCT = MARGINAL REVENUE PRODUCT OF LABOR
8
7
6
5
4
3
2
1
$16
$14
$12
$10
$8
$6
$4
$2

24. SL*
$16
PLOT THESE
POINTS to get
A NEW MRPL
Curve
“A”

25. SL*
$16
Connect these Points
For form a NEW MRPL curve
“A”

26. SL*
$16
D1 = MRPL1
Notice we are at a NEW equilibrium, Point
“B”. The wage DID NOT CHANGE but the
number of workers the firm can hire at
$6.00 per hour has INCREASED to 6!
“B”“A”

27. SL*
$16
D1 = MRPL1
***When PRODUCTIVITY
INCREASES the MRP of Labor
Curve shifts to the RIGHT and the
firm can hire more workers.
“B”“A”

28. SL*
$16
Ok, let’s start over and change the Price.
Assume the Price the Perfectly
Competitive Firm receives for the Good
INCREASES to $3.00.
“A”
$3
$3
$3
$3
$3
$3
$3
$3

29. SL*
$16
Now re-calculate MRP of Labor
by taking MP X New Price.
“A”
$3
$3
$3
$3
$3
$3
$3
$3 $18
$15
$12
$9
$6
$3
$0
-$3

30. SL*
$16
D1 = MRPL1
If we plot these MRP of Labor
points we get a new MRPL curve
that lies to the RIGHT of the old
one and the NEW equilibrium
point is “B” at 5 workers.
“B”“A”
$3
$3
$3
$3
$3
$3
$3
$3 $18
$15
$12
$9
$6
$3
$0
-$3

31. Bottom Line on Shifting the MRP of
Labor Curve
• An increase in Productivity will Shift it to the RIGHT
allowing the firm to hire MORE workers.
• An increase in the Price will shift it to the RIGHT
allowing the firm to hire MORE workers.
• A decrease in Productivity will Shift it to the LEFT and
FEWER workers will be hired
• A decrease in the Price will Shift it to the LEFT and
FEWER workers will be hired.

32. What happens when there is a change
in the MARKET WAGE??
• In the Market for Labor things can change to
either affect the Demand for Labor and/or the
Supply of Labor.
• Let’s look at how the Firm responds to
changes in the Wage that they have NO
control over (ceterus paribus assumption)

33. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
Look at the Market for Labor graph on the RIGHT. There are TWO things that could cause the Wage
Rate to INCREASE.
1. An INCREASE in DEMAND for Labor shifting the Demand curve to the RIGHT
2. A DECREASE in SUPPLY of Labor shifting the Supply curve to the LEFT
“A” “A”

34. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
Let’s shift the Demand Curve to the RIGHT suggesting there is an INCREASE in Demand for Labor in
This market.
The NEW MARKET WAGE IS $10.00
“A”
DL 1
QL 1
W1 ($10)
“B”

35. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
Because the Firm is a Wage Taker, the Firm Supply Curve for Labor SHIFTS UP!
“A”
DL 1
QL 1
W1 ($10)
“A”
“B”

36. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
Now, the Firm has to look at how this new wage matches up with its own
Labor Demand curve---D* = MRPL*
Remember the Profit Maximizing Quantity of Labor:
MRC (W) = MRPL
The firm now finds that only 2 workers will be necessary.
“A”
DL 1
QL 1
W1 ($10)
“B” “B”
“A”

37. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
Now, look at how the firm responds if there is a DECREASE in the Market Wage.
This could happen if:
1. Demand for Labor DECREASES
2. Supply of Labor INCREASES
“A” “A”

38. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
Let’s shift the Demand Curve to the LEFT suggesting there is an DECREASE in Demand for Labor in
This market.
The NEW MARKET WAGE IS $4.00
“A”
DL 1
QL 1
W1 ($4.00)
“B”

39. Market for Labor
Wage
(w)
Quantity of Labor
QL*
W* ($6.00
DL*
SL*
The Firm is a Wage Taker so the new Firm Supply Curve will shift DOWN.
There is a new equilibrium in on the FIRM graph where:
MRC ($4.00/hour) = MRPL ($4.00)
The firm will INCREASE hiring to 5 Workers
“A”
DL 1
QL 1
W1 ($4.00)
“B”
“B”

40. Bottom Line
• If the firm is hiring in a Perfectly Competitive Labor Market:
• It will hire more workers if the wage decreases
• It will hire fewer workers if the wage increases
CETERUS PARIBUS!!
If wage rate increases, as in a higher minimum wage this can
be offset by what we learned prior to this:
If those workers become MORE productive and/or the Price of
the good they produce INCREASES.
This is an important part of the debate about increasing the
Minimum Wage.