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Chapter 8 The Labor Market Labor Supply • The willingness and ability to work specific amounts of time at alternative wage rates in a given time period, ceteris paribus. Labor Supply Income vs. 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. Income vs. Leisure • As the opportunity cost of work increases, we require higher rates of pay. • The marginal utility of income declines as more is earned. Income vs. Leisure • The upward slope of an individual labor supply curve reflects two things: – Increasing opportunity cost of labor. – Decreasing marginal utility of income. 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. 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. The Demand for Labor 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. 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. The Wage Rate • The quantity of labor demanded depends on its price - the wage rate. Marginal Physical Product (MPP) • We measure a worker’s value to the firm by his or her marginal physical product (MPP). Marginal Physical Product (MPP) • Marginal physical product – the change in total output associated with one additional unit of input: Marginal physical product = change in total output change in quantity of labor Marginal Physical Product (MPP) • In most situations, the marginal physical product declines as more workers are hired. Marginal Physical Product (MPP) Marginal Physical Product (MPP) Marginal Revenue Product (MRP) • Marginal revenue product – the change in total revenue associated with one additional unit of input: Marginal revenue product = change in total revenue change in quantity of labor Marginal Revenue Product (MRP) • Marginal revenue product sets an upper limit to the wage rate an employer will pay. Marginal Revenue Product (MRP) 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 as more people must share limited facilities. 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. The Law of Diminishing Returns 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. Diminishing Marginal Revenue Product (MRP) The Hiring Decision • How many workers that will be hired is determined by the demand for and supply of labor. 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. 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. The Labor-Demand Curve 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. Market Equilibrium • The market supply of labor depends on: – The number of workers. – Each workers’ willingness to work at alternative wage rates. 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. Equilibrium Wage Equilibrium Employment • The only sustainable level of employment in a market given the prevailing supply and demand conditions. 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 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. 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. Shifts in Labor-Demand 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). Minimum-Wage Effects 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 aboveequilibrium wage. Labor Unions • Unions decrease wages in non-union industries. • Excluded workers increase non-union labor supply. The Effect of Unions on Relative Wages 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. 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. The Labor Market End of Chapter 8