Download Lecture Notes 12 on Chapter 11

The Labor Market
Lecture by: Jacinto F. Fabiosa
Fall 2005
Product Markets
• Markets in which firms sell
goods and services to
households or other firms
• Products made from the
economy’s resources
2
Factor Markets
• Markets in which resources are
sold to firms
–Resources include
• Capital, land, labor, and natural
resources
• Resources are sometimes
called factors of production
3
Product and Factor Markets
4
Labor Markets in Particular
• Determining a worker’s wage rate
– Groups of economic decision makers come
together in markets in order to trade
– Each decision maker tries to maximize
something and faces constraints
– Observe equilibrium price determined in those
markets
– Explore how various changes affect that
equilibrium price
5
Special Meaning
• The special meaning of the price in the
labor market—the wage rate
– Income people earn over their lifetime will
determine how they will be able to provide for
themselves and their families
– Adds a special moral dimension to events in
labor markets
6
Defining a Labor Market
• How broadly or narrowly we define a
market depends on the specific questions
we wish to answer
– Broadly defined markets may look at markets
that draw on labor from all over the world
– Narrowly defined markets may look at markets
that draw on labor on a very localized level
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Competitive Labor Markets
• Market with many indistinguishable sellers
of labor and many buyers
– Involves no barriers to entry or exit
– Perfectly competitive labor markets must
satisfy three conditions
• Great many buyers (firms) and sellers (households)
of labor in market
• All workers in market appear the same to firms
• No barriers to entering or leaving labor market
8
Firms in Labor Markets
• Sometimes firms that compete in the same product
market also compete in the same labor markets, but
– Some firms that compete in the same product market operate in
different labor markets
– Some firms that operate in different product markets compete in
the same labor market
• The demand side of a labor market includes all firms hiring
labor in that labor market
– These firms may (but not necessarily) compete in the same
product market
9
Derived Demand
• The demand for labor is a derived
demand―it arises from, and will vary
with—the demand for the firm’s output
– The phrase “will vary with” is important
• The demand for labor by a firm will change
whenever demand for the firm’s product
changes
10
Resource Demand: A General Rule
• Marginal approach to profit
– Firm should take any action that adds more to its revenue than it adds to
its cost
• When we view firm as a buyer in a resource or factor market, we use
same principle of marginal decision making
– This time action under consideration is “increase employment of the
resource by another unit”
– Rule becomes
• Increase employment of any resource whenever doing so adds more to
revenue than it adds to cost
– To avoid confusion between decisions about resources and decisions
about output, we don’t use terms “marginal revenue” and “marginal cost”
when discussing factor markets
• To track changes on the revenue side, use term “marginal revenue product”
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Marginal Revenue Product (MRP)
• The change in firm’s total revenue divided
by change in its employment of a resource
Marginal Revenue Product (MRP) 
change in total revenue ( TR )
change in quantity of resource ( L)
When firm thinks about changing resource by one unit at a time
MRP is the change in the firm’s revenue when it employs one more unit of the
resource
12
Marginal Factor Cost (MFC)
• To track changes on the cost side, we use the term
marginal factor cost
Marginal Factor Cost (MFC) 
change in total cost ( TC )
change in quantity of resource ( L)
The MFC tells us the rise in cost per unit increase in the resource
When Δ Quantity of Resource = 1 MFC is increase in cost from employing one more
unit of resource
13
Marginal Approach to Profit
• To maximize profit firm should increase its employment of any
resource whenever MRP > MFC
– But not when MRP < MFC
• Profit-maximizing quantity of any resource is quantity at which MRP =
MFC
• If MRP > MFC, employing more of resource increases revenue more
than cost
– Profit will rise
• When MRP < MFC, using more of resource adds more to cost than to
revenue
– Profit falls
• When firm exploits every opportunity to increase profit it will arrive at
the point at which MRP = MFC
14
The Firm’s Employment Decision When
Only Labor Is Variable
• The Firm’s MRP in a Competitive Product Market
– When output is sold in a competitive product market
• MRP for any change in employment will equal price of output
(P) times marginal product of labor (MPL)
– MRP = P x MPL
• The Firm’s MFC in a Competitive Labor Market
– When labor is hired in a competitive labor market, MFC
for any change in employment will equal market wage
rate (W)
• MFC = W
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The Profit-Maximizing Employment Level
• Marginal approach to profit
– A firm should take any action that adds more to
its revenue than to its cost
• Hire another worker when MRP > W, but not
when MRP < W
• To maximize profit, the firm should hire the
number of workers such that MRP = W
– Where the MRP curve intersects the wage line
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The Profit-Maximizing Employment Level
Dollars
$200
150
100
Wage
60
50
MRP
1
2
3
4
5
6
7
8
Number
of Workers
17
The Two Approaches to Profit
Maximization
• Two different approaches for the firm to follow to maximize profit
– MR and MC approach to find profit-maximizing output
– MRP and MFC approach to find profit-maximizing employment
• Can these two approaches lead to different decisions?
– No, because these two “different” approaches are actually the same
method viewed in two different ways
– Remember that hiring another worker increases the firm’s output and
therefore changes both its revenue and its cost
• Whenever MRP > MFC for a change in employment, MR > MC for
associated rise in output
• Whenever MRP < MFC for a change in employment, MR < MC for
associated rise in output
• If MRP = MFC for a change in employment, MR = MC for associated
change in output
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The Firm’s Labor Demand Curve
• When labor is the only variable input,
downward-sloping portion of MRP curve is
firm’s labor demand curve
– Tells us how much labor firm will want to
employ at each wage rate
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The Firm’s Labor Demand Curve
Dollars
W1
Firm’s
Labor Demand
Curve
A
B
W2
n1
n2
W1
W2
Number of Workers
20
The Firm’s Employment Decision When
Several Inputs are Variable
• Whether the firm can vary just labor, or
several inputs simultaneously
– Optimal level of employment will satisfy the
MRP = W rule
• Firm’s labor demand curve will slope
downward
• Decrease in wage rate will cause an
increase in employment
21
The Employment Decision with Several
Variable Inputs
Dollars
A
W1
W1
B
C
W2
W2
MRP
n
1
n
2
MRP
1
n
2
Firm’s
Labor
Demand
Curve
Number of Workers
3
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The Market Demand For Labor
• Market Labor Demand Curve
–Indicates total number of workers all
firms in a labor market want to
employ at each wage rate
–Found by horizontally summing
across all firms’ individual labor
demand curves
23
The Market Demand For Labor
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A Shift in the Labor Demand Curve
(a)
Typical Firm
Hourly
Wage
$10
(b)
Labor Market
Hourly
Wage
A
B
n2
Number
of Workers
B
D
L2
D
L1
l 2d
l 1d
n1
A
N1
N2
Number
of Workers
25
Shifts in the Market Labor Demand
Curve
• A change in any variable that affects
quantity of labor demanded—except for the
wage rate—causes labor demand curve to
shift
• Specific variables that shift the labor
demand curve include a change in
– Demand for the firm’s product
– Technology
– Prince of another input
– Number of firms
26
A Change in Demand for the Firm’s
Output
• Effect of a change in output price on labor
demand depends on whether many firms in
the labor market also share the same
product market
• When they do
– A rise in output price will shift market labor
demand curve rightward
– A fall in output price will shift market labor
demand curve leftward
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A Change in Technology
• Complementary Input
– An input whose utilization increases
marginal product of another input
• Substitute Input
– An input whose utilization decreases
marginal product of another input
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A Change in Technology
• When many firms in a labor market
acquire a new technology, the market
labor demand curve will shift
– Rightward if technology is complementary
with labor
– Leftward if technology is substitutable for
labor
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Introducing a New Input
Hourly
Wage
More
of a
More
of a Complementary
Input
Substitutable
Input
l d2
l d1
l d3
Number
of Workers
30
A Change in the Price of Another Input
• When price of some other input
decreases, market labor demand
curve may shift
–Rightward if the input is
complementary with labor
–Leftward if the input is substitutable
for labor
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Individual Labor Supply
• Individuals as wage takers
– No single labor seller can affect the
market wage
– In a competitive labor market
• Each seller is a wage taker
– He or she takes market wage rate as given
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The Income-Leisure Trade-off
• Wage rate determines exact nature
of the income-leisure trade-off
–Higher the income »» higher the
expense of leisure time
33
The Labor Supply Decision
• Individuals who are able to choose their
own hours may
– Choose optimal combination of income and
leisure
• Individuals who are not able to choose their
own hours
– Only make the choice of whether to offer their
labor in a particular market or not
34
Reservation Wages
• Lowest wage rate at which an
individual would supply labor to a
particular labor market
• When wage rate in a market exceeds
an individual’s reservation wage for
that market
– Individual will decide to work there
35
Market Labor Supply
• Curve indicating the number of
people who want jobs in a labor
market at each wage rate
–The higher the wage rate, the greater
the quantity of labor supplied
36
Figure 8: The Market
Labor Supply Curve
37
Shifts in the Market Labor Supply Curve
• A market labor supply curve will shift when
– Something other than a change in wage rate causes a
change in number of people who want to work in a
particular market
• Factors causing a labor supply curve to shift
include
–
–
–
–
Change in market wage rate in other labor markets
Changes in cost of acquiring human capital
Number of qualified people
Changes in tastes
38
A Change in the Market Wage Rate in
Other Labor Markets
• As long as some individuals can
choose to supply their labor in two
different markets
– A rise in wage rate in one market will
cause a leftward shift in labor supply
curve in other market
39
Changes in the Cost of Acquiring Human
Capital
• An increase in the cost of acquiring human
capital will shift the labor supply curve
leftward
• A decrease in the cost of acquiring human
capital will shift the labor supply curve
rightward
40
Number of Qualified People
• Population growth causes labor supply
curves in both national and local labor
market to shift rightward over time
• Labor supply curves can also shift due
to migration within a country
• If new people entering a field exceeds
number of retirees in that field
– Increase in supply results
41
Changes in Tastes
• Different types of jobs attract
different people with different
tastes
–Danger and excitement vs. safety
and routine
• Women entering the workforce
• Social contribution to community
42
Short-Run vs. Long-Run Labor Supply
• Short-run
– Labor supply response to a wage-rate change comes
from those who already have skills and geographic
location needed to work in a market
• Long-run
– Labor supply response to a wage-rate change comes
from those who will acquire skills and move into
geographic location needed to work in a market
43
Short-Run vs. Long-Run Labor Supply
• Long-run labor supply curve indicates
how many (qualified) people will want
to work in a labor market
– After full adjustment to a change in the
wage rate
• Long-run labor supply response is
more wage elastic than short-run labor
supply response
44
The Long-Run Labor Supply Curve
Hourly
Wage
S
S
L1
S
LLR
B
$40
25
L2
C
A
30,000
60,000
90,000
Number of Workers
45
Labor Market Equilibrium
• Supply and demand will drive a
competitive labor market to its
equilibrium point
–Point where the labor supply and
labor demand curves intersect
46
Labor Market Equilibrium
47
What Happens When Things Change?
• Events that can cause labor demand
curve and labor supply curve to shift
include
– Change in labor demand
– Change in labor supply
– Labor shortages and surpluses
48
A Change in Labor Demand
• In short-run, shift in labor demand
moves along a short-run labor
supply curve
• In long-run, resulting increase in
wage rate will cause short-run
labor supply curve to shift also
49
A Change in Labor Demand
Labor Market
Typical Firm
Dollars
S
L1
Wage
S
L2
B
$40
C
30
20
b
$40
c
30
D
A
L2
20
W2
a
W3
W1
l2d
l1d
D
L1
5,000 8,000 12,000
Number
of Workers
50
80
120
Number
of Workers
50
Change in Labor Supply
• Shifts in labor supply typically happen
slowly
• When a long-run change in labor
supply is the cause of changes in the
labor market
– No separate short-run change in
equilibrium to investigate
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The Market For Finance Professors
(1995-2002)
Annual
Wage
S
L2
S
L1
B
$91,200
66,900
A
D
L2
D
L1
N1N2
Number
of New Finance
52
Labor Shortages and Surpluses
• Labor Shortage
– Quantity of labor demanded exceeds
quantity supplied at prevailing wage rate
• Labor Surplus
– Quantity of labor supplied exceeds
quantity demanded at prevailing wage
rate
53
Labor Shortages and Surpluses
• Shortages and surpluses in a labor market
are not natural consequence of shifts in
supply and demand curves
– Labor shortage will occur only when wage rate
fails to rise to its equilibrium value
– Labor surplus will occur only when wage rate
fails to fall to its equilibrium value
54
Using the Theory: Understanding the Market
for College-Educated Labor
• Students have many motives for attending college
• One of the most important motives is to invest in
their own human capital
– Going to college will enable you to earn a higher
income than you would otherwise be able to earn
– Economists track the college wage premium
• Percentage by which average college graduate’s income
exceeds average high school graduate’s income
– Wage premium was relatively stable in 1960s and 1970s, at
around 40 to 50%
– But premium began to rise sharply in 1980s and continued its rise
through 1990s
– By 2001 college wage premium reached 76% for men and 97%
for women
55
Using the Theory: Understanding the Market
for College-Educated Labor
• Why did labor supply shift rightward each
year?
– An increase in proportion of young people
attending college
– Population itself increased
• Why did labor demand curve shift rightward
each year?
– Partly due to normal growth in economy
– Technological change
• Increase skill requirements for many types of work
56
The Market for College-Educated Labor
57
Using the Theory: Understanding the Market
for College-Educated Labor
• An increase in yearly wage rate has resulted over
last two decades
– Because demand curve for college graduates shifted
rightward faster than supply curve
• What will happen in the future?
– Competing trends
• Acceleration in rightward shift of labor supply curve for college
graduates
– Will work to decrease college wage premium
• Acceleration in rightward shift of labor demand curve for
college graduates
– Due to further changes in technology
58
Using the Theory: Understanding the Market
for College-Educated Labor
• Most labor market economists predict
– For college-educated labor
• Labor demand curve will shift rightward more rapidly
than labor supply curve over next several years
• Wage rate for college graduates is expected to rise
– For high school graduates
• Shifts in labor supply curve are expected to outpace
shifts in demand curve
– Wage premium for college students is expected to increase
59