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The Labor
Market
Chapter 8
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Labor Supply
• The willingness and ability to work
specific amounts of time at alternative
wage rates in a given time period,
ceteris paribus.
LO-1
8-2
Income versus Leisure
• The opportunity cost of working is the
amount of leisure time that must be
given up in the process:
– Opportunity cost is the most desired
goods or services that are forgone in
order to obtain something else.
LO-1
8-3
Income versus Leisure
• As the opportunity cost of work
increases, we require higher rates of
pay.
• The marginal utility of income declines
as more is earned.
• The upward slope of an individual labor
supply curve reflects two things:
– Increasing opportunity cost of labor.
– Decreasing marginal utility of income.
LO-1
8-4
Market Supply
• Market supply of labor–the total
quantity of labor that workers are
willing and able to supply at alternative
wage rates in a given time period,
ceteris paribus.
• As labor-market entrants increase, the
quantity of labor supplied goes up.
LO-1
8-5
Labor Demand
• Demand for labor–the quantities of
labor employers are willing and able to
hire at alternative wage rates in a given
time period, ceteris paribus.
LO-2
8-6
Derived Demand
• Derived Demand–The demand for
labor and other factors of production
results (is derived) from the demand for
the final goods and services produced
by these factors.
LO-2
8-7
Derived Demand
• The quantity of resources purchased
by a business depends on the firm’s
expected sales and output.
• The demand for labor depends on the
demand for the product that the labor is
producing.
LO-2
8-8
What does your
major pay?
8-9
The Wage Rate
• The quantity of labor demanded
depends on its price—the wage rate.
• The farmer paying $30 an hour to labor
may not hire as much labor as she
would at $10 per hour.
LO-3
8-10
Figure 8.2
8-11
Marginal Physical
Product (MPP)
• We measure a worker’s value to the
firm by his or her marginal physical
product (MPP).
LO-3
8-12
Marginal Physical
Product (MPP)
• Marginal physical product–the
change in total output associated with
one additional unit of an input:
MPP =
change in total output
change in quantity of labor
LO-3
8-13
Marginal Physical
Product (MPP)
• In most situations, the marginal
physical product declines as more
workers are hired.
LO-3
8-14
Marginal Revenue
Product (MRP)
• Marginal revenue product–the
change in total revenue associated
with one additional unit of input:
MPP =
change in total revenue
change in quantity of labor
LO-3
8-15
Marginal Revenue
Product (MRP)
• Marginal revenue product sets an
upper limit to the wage rate an
employer will pay.
LO-3
8-16
The Law of
Diminishing Returns
• The marginal physical product of labor
eventually declines (or diminishes) as
the quantity of labor employed
increases.
• Marginal physical product declines
because more people must share
limited facilities.
LO-3
8-17
The Law of
Diminishing Returns
• 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.
LO-3
8-18
Figure 8.3
8-19
Diminishing Marginal
Revenue Product (MRP)
• As MPP diminishes, so does MRP.
MRP = MPP x p
• If p is assumed to be constant, then
MRP diminishes along with MPP.
LO-3
8-20
Table 8.1
8-21
The Hiring Decision
• The number of workers that will be
hired is determined by the demand for
and the supply of labor.
LO-3
8-22
The Firm’s Demand
for Labor
• A firm will continue to hire until the
MRP has declined to the level of the
market wage rate.
• The Marginal Revenue Product curve
is the labor demand curve.
LO-3
8-23
The Firm’s Demand
for Labor
• Each (identical) worker is worth no
more than the MRP of the last worker
hired, and all workers are paid the
same wage rate.
LO-3
8-24
Figure 8.4
8-25
Market Equilibrium
• The market demand for labor depends
on:
– The number of employers.
– The Marginal Revenue Product of labor in
each firm and the industry.
• The market supply of labor depends on:
– The number of workers.
– Each workers’ willingness to work at
alternative wage rates.
LO-3
8-26
Equilibrium Wage
• The intersection of the market supply
and demand curves establishes the
equilibrium wage.
• It is the only wage where the quantity
of labor supplied equals the quantity of
labor demanded.
LO-3
8-27
Equilibrium
Employment
• The only sustainable level of
employment in a market given the
prevailing supply and demand
conditions.
LO-3
8-28
Changing Market
Outcomes
• Changing market conditions alter
wages and employment levels.
– Changes in labor productivity
– Changes in the price of the good
produced by labor
– Legal minimum wages
– Labor unions
LO-5
8-29
Changes in
Productivity
• If labor productivity (MPP) rises, wages
can increase without sacrificing jobs.
• Increased productivity implies that
workers can get higher wages without
sacrificing jobs or more employment
without lowering wages.
LO-5
8-30
Changes in Price
• Marginal revenue product reflects the
interaction of productivity and product
prices.
• MRP depends on the market price of
the product being produced.
• MRP shifts to the right if the market
price of a product increases.
LO-5
8-31
Legal Minimum Wages
• Minimum wages are mandated by
Congress.
• Effects of a minimum wage:
– Reduces the quantity of labor demanded.
– Increases the quantity of labor supplied.
– Creates a market surplus.
– Some workers end up better off while
others end up worse off (a tradeoff).
LO-4
8-32
Figure 8.7
8-33
Labor Unions
• Workers may take collective action to
get higher wages.
• They form a labor union and bargain
collectively with employers.
• A union must exclude some workers
from the market to get and maintain an
above-equilibrium wage.
LO-5
8-34
Labor Unions
• Unions decrease wages in non-union
industries.
– Excluded workers increase non-union
labor supply.
LO-5
8-35
Capping CEO Pay
• Critics of CEO (Chief Executive Officer)
pay levels want to reduce their pay and
revise the process used to set their pay
levels.
• The Obama Administration created a
Pay Czar position to govern salaries
and benefits given to CEOs of firms
bailed out during the 2008-09
economic problems.
LO-5
8-36
Unmeasured MRP
• Measuring the MRP of a CEO is
difficult because a CEO’s contributions
are not easy to quantify.
• CEO salaries are higher because they
reflect their opportunity wage:
– Opportunity wage is the highest wage an
individual would earn in his or her best
alternative job.
LO-5
8-37
End of
Chapter 8