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CHAPTER 10 The labour market ©McGraw-Hill Education, 2014 Some important questions • Why does a top professional footballer earn so much more than a professor? • Why does an unskilled worker in the EU earn more than an unskilled worker in India? • Why do market economies not manage to provide jobs for all their citizens who want to work? • Why are different methods of production used in different countries? ©McGraw-Hill Education, 2014 The demand for labour • Derived demand – the demand for a factor of production is derived from the demand for the output produced by that factor • Equilibrium wage differential – the monetary compensation for the differential non-monetary characteristics of the same job in different industries – so workers have no incentive to move between industries ©McGraw-Hill Education, 2014 The demand for labour in the short run The marginal value product of labour (MVPL) is simply the marginal product of labour in physical goods MPL multiplied by the output price. • Under perfect competition, with diminishing marginal productivity, the firm maximizes profit when the marginal cost of employing an extra worker equals the MVPL. W0 MVPL Employment ©McGraw-Hill Education, 2014 The demand for labour in the short run W0 E MVPL …this occurs at E where wage = MVPL. Employment is L*. Below L*, extra employment adds more to revenue than to labour costs. Above L*, the reverse is so. This decision is consistent with the MR = SMC rule for maximizing profit under perfect competition. L* Employment ©McGraw-Hill Education, 2014 Demand for factors in the long run (1) • The optimum mix of capital and labour depends on the relative prices of each input. • This helps to explain why more labour-intensive means of production are used in some countries where labour is relatively abundant. ©McGraw-Hill Education, 2014 Demand for factors in the long run (2) • A change in the price of one factor will have both output and substitution effects. • A rise in the wage rate leads to – substitution towards more capital-intensive techniques, – but also leads to lower total output. ©McGraw-Hill Education, 2014 Monopoly &monopsony power in the labour market • A firm may have MONOPOLY power in its output market – facing a downward-sloping demand curve – so the marginal revenue product of labour (MRPL) received from expanding output is less than the MVPL as the firm must reduce price to sell more. • A firm may face MONOPSONY power in its input market – facing an upward-sloping supply curve for inputs – so the marginal cost of labour rises with employment. ©McGraw-Hill Education, 2014 Monopoly & monopsony power (2) £ Under perfect competition, a firm sets MVPL = W0 and employs L1 workers. W0 MRPL L3 MVPL L1 Employment ©McGraw-Hill Education, 2014 Facing a downwardsloping demand curve for its product, the firm sets MRPL = W0 and employs L3 workers. Monopoly & monopsony power (3) £ MCL A monopsonist recognises that additional employment bids up wages for existing workers, so MCL shows the marginal cost of an extra worker. W0 MRPL L3 L2 MVPL L1 Employment Facing a given goods price, the monopsonist sets MCL = MVPL and employs L2 workers. ©McGraw-Hill Education, 2014 Monopoly & monopsony power (4) £ MCL W0 For a monopsonist who also faces a downwardsloping demand curve for the product, MCL is set equal to MRPL to employ L4 workers. So monopoly and monopsony power both tend to reduce the firm’s demand for labour. L4 L3 L2 L1 Employment ©McGraw-Hill Education, 2014 The supply of labour • The LABOUR FORCE – all individuals in work or seeking employment. • Labour supply – for an individual, the decision on how many hours to offer to work depends on the real wage – an individual’s attitude towards leisure and income determines will influence how many hours of work are supplied at any given real wage rate. ©McGraw-Hill Education, 2014 The individual’s supply curve of labour SS2 SS1 Hours of work supplied ©McGraw-Hill Education, 2014 For the labour supply curve SS1, an increase in the real wage always Induces higher labour supply. Whereas for SS2, there comes a point where a higher wage induces less hours of work to be supplied: labour supply is backward-bending. Labour supply in aggregate • If we consider the economy as a whole, or an industry a higher real wage rate also encourages a higher participation rate. • Higher wage rates encourage those already working to supply more hours and those not working to enter the labour force. ©McGraw-Hill Education, 2014 Labour market equilibrium for an industry SL DL • The industry supply curve SLSL slopes up – higher wages are needed to attract workers into the industry W0 DL SL L0 Quantity of labour • For a given output demand curve, industry demand for labour slopes down • Equilibrium is W0, L0. ©McGraw-Hill Education, 2014 A shift in product demand DL Beginning in equilibrium, D'L A fall in demand for the product also shifts the derived demand for labour to D'L W0 W1 D'L L1 L0 DL The new equilibrium is at W1, L1. Quantity of labour ©McGraw-Hill Education, 2014 A change in wages in another industry SL DL Again starting in equilibrium, an increase in wages in another industry attracts labour, W0 DL SL L0 Quantity of labour ©McGraw-Hill Education, 2014 Transfer earnings and economic rent • Transfer earnings – the minimum payments required to induce a factor of production to work in a particular job. • Economic rent – the extra payment a factor receives over and above the transfer earnings needed to induce the factor to supply its services in that use. ©McGraw-Hill Education, 2014 Wage Transfer earnings and economic rent (2) In labour market equilibrium at W0, L0, D SS if workers were paid only the transfer earnings, the industry would need only pay AEL0 in wages. E W0 D 0 A L0 Quantity But if all workers must be paid the highest wage needed to attract the marginal worker into the industry (W0), then workers as a whole derive economic rent of 0AEW0. ©McGraw-Hill Education, 2014 Concluding comments (1) • The demand for labour is derived from the demand for what it is used to produce. • Firms stop hiring workers when the value of what they produce (VMPL) begins to fall below what it costs to hire them (W). • Labour supply will fall as the wage increases if the income effect dominates the substitution effect. • A lack of competition on the buying side of the labour market (monopsony) is associated with lower employment and wages when compared to a perfectly competitive market. ©McGraw-Hill Education, 2014 Concluding comments (2) • For someone already in the labour force, a rise in the hourly real wage has both a substitution effect tending to increase the supply of hours worked, and an income effect tending to reduce the supply of hours worked. • Economic rent is the difference between income received and the reservation wage for that individual. • In free market equilibrium, some workers choose not to work at the equilibrium wage rate. They are voluntarily unemployed. ©McGraw-Hill Education, 2014 Concluding comments (3) • Involuntary unemployment is the difference between desired supply and desired demand at a disequilibrium wage rate. • Possible causes of involuntary unemployment are minimum wage agreements, trade unions, scale economies, insider–outsider distinctions and efficiency wages. ©McGraw-Hill Education, 2014