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The Labor Market
Labor Supply: (labor is supplied by workers)
In economics, we assume everybody wants to make as much as possible from
their jobs. This assumption is called income maximization. This assumption is
arrived at because the economist assumes everyone is rational. Does everyone
want to make as much money as possible?
Like any supply curve it is upward sloping to the right (Fig 8.1) because:
Increasing opportunity cost of working. We need some leisure time so
even the highest of wages will not motivate us to work all of the time.
Marginal utility of income – what is this?
-utility declines as you earn more in the higher salary levels
Labor Demand: (demand comes from the employers)
The demand for labor is ‘derived demand’ What is the demand for labor derived
The demand for labor is downward sloping to the right (Figure 8.2). Why?
Marginal Physical Product (MPP. Fig 8.3) – this measures change in output of
employing one additional unit of input (worker).
The mathematical formula is:
Change in output
MPP = ------------------------Change in Qd of labor
We can see MPP in action by the following activity
What do we notice about the MPP?
If the worker was paid in strawberries, the strawberry grower will not pay
an additional worker more than the number of strawberries (s)he picks.
The worker however will probably not be paid in strawberries. S/he will be paid
in cash so we need to calculate: Marginal Revenue Product (MRP)-See textbook
If we convert the value of strawberries into cash we would have MRP. In other
words, the dollar value of MPP is called MRP
The mathematical formula is:
Change in total revenue
MRP ---------------------------Change in quantity of labor
We will not be using the formula but, we can see MRP in action by the following
1. Calculate Total Revenue (P multiplied by Quantity) if price of each clip
is $2 (what a rip!)
2. Calculate the Marginal Revenue product of employing each worker
3. Draw a graph consisting of MRP on the vertical and quantity of labor
on the horizontal axis. Plot MRP
4. At a wage of $12 per hour how many workers will you hire?
Hint 1: An employer will employ the extra worker if the revenue
s/he earns the employer is more than the paycheck
Hint 2: An employer will not employ the extra worker if the
revenue s/he earns the employer is less than the paycheck.
Hint 3: Draw a horizontal line at $12 Where do MRP and the wage
rate intersect?
5. If the wage rate goes up 25%, what happens to the number of workers
you hire
6. If wages goes down 25%, what happens to the number of workers
Therefore: A firm will continue to hire additional units of labor until:
MRP = Market wage rate (see fig 8.4)
OK so I see how MRP is calculated but, what sets the wage rate?
Market Equilibrium sets the wage rate:
If we add up all the demand for workers (from the employers) and all the supply
of workers (from individuals) in a profession, we will have the market demand
and market supply of workers in a particular profession e.g. teachers
The equilibrium point (where demand and supply cross) gives the wage rate and
employment level (fig 8.5). Everyone who is willing and able to work for this
wage will find a job. (This wage does not mean everyone is happy!)
Changing Market Conditions
Increases in minimum wages create lower demand for workers and therefore an
excess supply of labor –see fig 8.7
Labor Unions use exclusion tactics to stop the jobless from eroding their union
negotiated wage rates. So the jobless then flood the non unionized labor market
and bring non union wage rates down.
……..So what of CEO pay? According to economics, how do they get their high
salary levels? If the economist says that they are worth a high wage rate, should
we take the economist’s word?
Arguments for and against please?
If you want good returns on your stock you have to pay for the people most likely to
bring you results.
But are the results all down to the CEO?
CEO’s then argue that if one company does not pay the high salary offered then some
other company will.
So what shall we do?
CAPS? Tax?
Who said the government should keep their hands off the economy? Do you still think
that way?