The document discusses the determination of wages through supply and demand, emphasizing that wages are essentially a price for labor, similar to the prices of goods. It explains how employers set wages based on the marginal revenue product of workers and how competitive market dynamics influence labor costs. Additionally, it addresses objections to these concepts and touches on the implications of minimum wage laws and labor unions on employment and wage rates.

1. Economic Reasoning, Lecture
3
Wages

2. Wages Are Prices
●In the first two lectures, I’ve contrasted
Austrian economics with neoclassical, or
mainstream, economics. But on wages, there
isn’t much difference between the schools.
●Hazlitt makes a fundamental point about
wages. Wages are a price, i.e., the price of
labor. There isn’t a separate theory of how
wages are determined.

3. Supply and Demand
●The basics of prices are simple.
Suppose I want to sell 5 apples. I offer
them for sale at a price—say, $5.00 an
apple. I probably won’t sell any.
●I will then lower my price until I succeed
in selling all the apples.

4. Supply and Demand
Continued
●What happens if I set the price at 1 cent per
apple? Then, I will probably find that people
will want more than 5 apples. Because I have
only 5 apples available, some people will offer
me more money.
●The price will stabilize when all the apples are
sold, and there are no buyers willing to offer a
higher price. At the stable, or equilibrium
price, the quantity of apples supplied (for
sale) equals the quantity demanded (bought).

5. Many Sellers
●Suppose that there are many people selling
apples. This doesn’t change things. Bidding
between buyers and sellers will lead to a
price at which what is offered for sale is
bought. At this price, no one who wants to
buy is turned away.
●Why is this true? If there are goods supplied
that people won’t buy (a surplus), sellers will
lower the price. If people want more of a
product than is available (a shortage), they

6. An Objection
●Very often, when you go into a store, you can’
t bargain about the price. When you eat at
McDonalds, you’re probably not going to say,
“How about $1.00 off on the Big Mac”? If so,
is it still true that supply and demand
determine price?
●Yes, it is. You don’t need actual bargaining. If
people don’t buy all the Big Macs at the price
that is set, the McDonald’s management will
lower the price. If they don’t have enough Big
Macs to supply their customers, they will raise

7. Wages
●Wage rates are set in exactly the same way.
Workers are selling their labor services.
Employers are the buyers. The wage rate for
a particular kind of labor will be set so that the
quantity supplied equals the quantity
demanded at that price.
●Again, it doesn’t matter if there is actual
bargaining. If employers don’t offer high
enough wages to lead as many workers as
they want to accept work, they will offer more
money.

8. The Bargaining Power
Objection
●Some people object that an individual worker
for a large company may have no bargaining
power. Suppose that someone has no other
job available than working for Wal-Mart.
(Assume no welfare benefits).
●If he loses the job, he faces starvation. Wal-
Mart could easily hire someone else in his
place. Doesn’t he have to accept whatever
wages Wal-Mart offers him?

9. Objection Answered
●It’s true that the Wal-Mart could easily get
along without this particular worker. But Wal-
Mart is in competition with other firms, both
large and small, that hire unskilled labor. If it
offers wages that are below standard, other
firms will bid their workers away.
●We can understand this better by thinking of a
buyer who offers an exceptionally low price
for an apple. He won’t get the apple if other
buyers offer more. In the same way, a large
company won’t get workers if others offer

10. A Mistake to Avoid
●Remember the Austrian view of competition.
An industry is competitive so long as entry
and exit is free, and all products compete for
money from consumers.
●The normal rules of price formation that we
have just explained apply so long as there is
competition in this sense. The rules don’t
change if some firms are very large.

11. What Determines Wage
Rates?
●We know that the wage for a particular
kind of labor will be set so that quantity
supplied and quantity demanded are
equal. But can we go further? What
determines how much labor is
demanded?
●An employer will want to hire a worker
so long as the worker contributes more

12. Marginal Product
●As more workers are hired, their value tends
to decrease. Why?
●This is an instance of a general economic
law, the law of diminishing marginal returns.
Suppose that you need labor + machines to
produce a car. If you hold one of these factors
of production constant, you can’t keep getting
more and more cars just by adding to the
other one. If , e.g., it takes a certain number
of workers to operate a car assembly line,
adding more than this number will after a

13. Diminishing Marginal Returns
●How does this law apply to a company like
Wal-Mart, which sells goods rather than
produces them?
●If Wal-Mart kept hiring sales clerks without
expanding the store, the clerks would
eventually get in each other’s way. Unlike the
law of diminishing marginal utility, where new
units of a good always have lower utility, you
can sometimes have increasing returns. But
they will eventually diminish.

14. Wages and Marginal Revenue
Product
●We know then, that as more workers are
hired, their marginal revenue product will go
down. The marginal revenue product
determines the wage rate.
●An employer won’t offer more than this,
because he would then be paying more than
the worker contributes to the product. It’s to
his advantage to hire workers as long as the
wage is slightly below their marginal product.
Note that all workers get the marginal wage.

15. An Objection
●Sometimes people object to the marginal
productivity theory of wages. The say it isn’t
possible to tell how much each factor of
production contributes to the value of the
product. E.g., how much do the sales clerks
contribute to Wal-Mart’s revenue?
●Very often you can tell, though, by seeing
what the factor of production earns in other
uses. How much do sales clerks earn in other
jobs? That gives a rough idea of their
contribution to this job.

16. Workers’ Productivity
●The workers’ marginal revenue product does
not mean what the worker contributes to the
product, solely by his own effort.
●If the employer puts in new machines, and
this enables a worker to produce more, then
the worker’s marginal revenue product has
gone up. His own skill may not have risen---
the new method may even require less skill
than before—but the worker benefits from the
capital investment of the employer.

17. Another Objection
●David Schweickart, a Marxist philosopher and
economist, objected to using the point about
workers’ productivity as an argument for the
free market.
●Against those who say that the worker
benefits from the machinery and tools that he
hasn’t created, Schweickart says, “Why aren’t
the tools and machinery owned by the
workers also? Why are they owned by the
employers?”

18. Response
●This objection ignores the fact that workers in
a free market can set up their own
businesses, if they want to do this. In some
cases they do, but in many cases, they prefer
to let others take the risks of investment.
●In any case, the objection doesn’t affect the
point that workers’ wages benefit from
increases in machinery and tools. This
increases their marginal revenue product.

19. Discounted Marginal Revenue
Product
●One point that we’ll just touch on is that
workers actually get, not the marginal
revenue product, but this product
discounted by the rate of interest.
●We don’t have to go into all the details
here, but the basic reason is that the
employer has to pay the workers before
he sells the product and makes money.

20. Minimum Wage Laws
●What happens if the government enacts
a minimum wage law? If the rate is
above the market wage for certain kinds
of labor, anyone worth less than that to
the employer won’t be employed.
●Minimum wages create an artificial
surplus of labor.

21. Are Minimum Wage Laws
Bad?
●If minimum wage laws cause unemployment,
does it follow that they are bad and that we
should get rid of them?
●This is an ethical judgment and doesn’t follow
from economic analysis. Economics just says
what will happen, not what ought to happen.
●However, as Mises points out, we can say
that from the point of view of the advocates of
minimum wage laws, these laws won’t
achieve their purpose. People who favor such
laws don’t want unemployment.

22. Are Minimum Wage Laws
Important?
●You might think minimum wage laws aren’t
important. The current federal minimum wage
is $7.25 an hour, and most people earn
substantially more than that.
●But a worker’s salary include all his benefits,
and sometimes laws impose requirements
about these. These include health insurance,
retirement benefits, vacation, sick leave etc.
These laws about benefits can cause
unemployment.

23. Interns
●We can see one effect of minimum wage laws
in the rise of unpaid interns in many
professions. Employers can’t offer below
minimum wages to young people entering the
job market.
●If they could, and interns were doing valuable
work, then employers would offer money to
lure away interns from their competitors.
Payment would rise until interns were earning
their discounted marginal revenue product.

24. Labor Unions
●If a labor union gets a wage increase for its
members that is above the market wage, then
the employer will either cut staff or not hire as
many new workers as he otherwise would
have.
●The workers who would have been employed
at the market rate have to seek jobs
elsewhere and they drive down wages in
these jobs.

25. Zones of Indeterminacy
●Sometimes labor union bargaining over
wages is defended in this way.Even though
the market tends toward an equilibrium price,
market conditions don’t strictly fix this price.
We can see this, e.g., in gasoline prices. The
price of gasoline in stations within a few miles
of each other will vary by a few cents. Union
advocates say there is a zone of
indeterminacy within which bargaining will
help.

26. Zones Continued
●There isn’t much evidence that these
zones exist or that, to the extent they
do, workers without unions end up in
the worst part of the zone for them.

27. Utility and Monopoly Prices
●One point from last time. I didn’t explain
clearly one of the objections to
neoclassical monopoly theory.
●The standard theory features a diagram
by which you can prove that a
monopoly price results in a deadweight
loss. The gain to the monopolist is less
than the loss to those who buy the

28. An Austrian Objection
●How is this diagram to be interpreted? What
do the boxes in it show? If you take them to
be dollar amounts, this makes sense, but not
if you take them to be showing a utility loss.
You can do this only if you take utility as
some sort of quantity. It doesn’t follow that
you have to think you can measure utility, but
the notion of increases or decreases in total
utility has to make sense. It’s difficult to see
how it could make sense, if utility only refers
to a ranking of goods.