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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