Download Principles of Economics Third Edition by Fred Gottheil

Chapter 15
WAGE RATES IN
COMPETITIVE LABOR
MARKETS
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Gottheil — Principles of Economics, 7e
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Economic Principles
Marginal physical product of labor
Marginal revenue product
The law of diminishing returns
Marginal labor cost
The profit-maximizing level
of employment
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Economic Principles
Firm and industry demand for
labor
The supply of labor
The backward-bending supply
curve of labor
Wage differentials
Minimum wage laws
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You Load Sixteen Tons and
What Do You Get?
Marginal physical product (MPP)
• The change in output that results from adding
one more unit of a resource, such as labor, to
production. MPP is expressed in physical units,
such as tons of coal, bushels of wheat, or
number of automobiles.
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You Load Sixteen Tons and
What Do You Get?
Marginal physical product (MPP)
• MPP = change in output (Q) divided by change in
the number of people employed (L).
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You Load Sixteen Tons and
What Do You Get?
Marginal physical product (MPP)
• Any change in MPP is attributed to the hiring
of one additional employee.
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EXHIBIT 1A OUTPUT AND MARGINAL PHYSICAL
PRODUCT CURVES
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EXHIBIT 1B OUTPUT AND MARGINAL PHYSICAL
PRODUCT CURVES
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Exhibit 1: Output and Marginal
Physical Product Curves
1. How can the shape of the total
output curve in panel a of Exhibit 1
be described?
• The total output curve is upward sloping,
increasing by large amounts until three
miners are employed, then increasing by
smaller and smaller amounts when more
than three miners are employed.
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Exhibit 1: Output and Marginal
Physical Product Curves
2. Why does the MPP curve in panel b
climb to a peak and then fall?
• The MPP curve maps the increases noted in
the total output curve. The MPP increases for
the first three miners, then falls as more
miners are added to production.
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You Load Sixteen Tons and
What Do You Get?
Law of diminishing returns
• As more and more units of one factor of
production are added to the production
process while other factors remain
unchanged, output will increase, but by
smaller and smaller increments.
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You Load Sixteen Tons and
What Do You Get?
Law of diminishing returns
• Adding more labor to a given stock of physical
capital must eventually create a less-thanefficient match of labor to capital.
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You Load Sixteen Tons and
What Do You Get?
Law of diminishing returns
• The law is demonstrated in the eventual
flattening of the total output curve and the
negative slope of the MPP curve.
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You Load Sixteen Tons and
What Do You Get?
Marginal revenue product (MRP)
• The change in total revenue that results from
adding one more unit of a resource, such as
labor, to production. MRP, which is expressed
in dollars, is equal to MPP multiplied by the
price of the good.
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You Load Sixteen Tons and
What Do You Get?
Marginal revenue product
• MRP = MPP × price
or
• MRP = change in total revenue (TR) divided
by change in labor (L)
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Deriving the Firm’s Demand
for Labor
The quantity of labor demanded
depends on price. If the price of
labor falls, the quantity demanded of
labor increases.
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Deriving the Firm’s Demand
for Labor
Wage rate
• The price of labor. Typically, the wage rate is
calculated in dollars per hour.
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Deriving the Firm’s Demand
for Labor
Total labor cost (TLC)
• Quantity of labor employed (L) multiplied by the
wage rate (W).
• TLC = L × W
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Deriving the Firm’s Demand
for Labor
Marginal labor cost (MLC)
• The change in a firm’s total cost that results
from adding one more worker to production.
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Deriving the Firm’s Demand
for Labor
Marginal labor cost (MLC)
• MLC = change in TLC divided by change in L.
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EXHIBIT 2A DERIVING THE MARGINAL LABOR COST
CURVE
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EXHIBIT 2B DERIVING THE MARGINAL LABOR COST
CURVE
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Exhibit 2: Deriving the Marginal
Labor Cost Curve
What causes the MLC curve to be
horizontal in panel b of Exhibit 2?
• The labor market is perfectly competitive.
Individual firms cannot influence the wage rate.
The firm can hire as many workers as it wants
at the prevailing wage rate. MLC is equal to the
wage rate.
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Deriving the Firm’s Demand for
Labor
The hiring rule for firms:
• Compare marginal revenue product and wage
rate and hire laborers until MRP = W.
• If MRP > W, hire more laborers.
• If MRP < W, don’t hire.
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EXHIBIT 3
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THE DEMAND FOR LABOR
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Exhibit 3: The Demand for Labor
Why is a firm’s demand for labor
equal to marginal revenue product
(MRP)?
• MRP reflects the maximum a firm is willing to
pay for an additional unit of labor.
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Exhibit 3: The Demand for Labor
Why is a firm’s demand for labor
equal to marginal revenue product
(MRP)?
• When the price of labor falls, firms can afford
to hire more labor, even though MRP declines.
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Deriving the Firm’s Demand
for Labor
Changes in the price of a good and
improvements in technology shift the
demand curve for labor to the right.
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EXHIBIT 4
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SHIFT IN THEA DEMAND CURVE FOR LABOR
CAUSED BY AN INCREASE IN THE PRICE OF
THE GOOD
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Exhibit 4: Shift in the Demand Curve
for Labor Caused by an Increase in
the Price of the Good
How does an increase in the price of
coal affect the number of miners hired
at a wage rate of $24?
• When the price of coal is $2, seven miners
are hired at a wage rate of $24.
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Exhibit 4: Shift in the Demand Curve
for Labor Caused by an Increase in
the Price of the Good
How does an increase in the price of
coal affect the number of miners hired
at a wage rate of $24?
• When the price of coal increases to $3, the
demand curve for miners shifts to the right.
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Exhibit 4: Shift in the Demand Curve
for Labor Caused by an Increase in
the Price of the Good
How does an increase in the price of
coal affect the number of miners hired
at a wage rate of $24?
• At the new coal price, nine miners are
demanded at the wage rate of $24.
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EXHIBIT 5
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THE DERIVATION OF MRP USING OLD AND
NEW TECHNOLOGY (PRICE OF COAL = $2)
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Exhibit 5: The Derivation of MRP
Using Old and New Technology
(Price of Coal = $2)
How does a change from old
technology to new technology affect
the MPP and MRP in Exhibit 5?
• With new technology the same miner is able
to produce twice as much coal.
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Exhibit 5: The Derivation of MRP
Using Old and New Technology
(Price of Coal = $2)
How does a change from old
technology to new technology affect
the MPP and MRP in Exhibit 5?
• The new technology doubles both MPP
and MRP.
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Industry Demand for Labor
If all of the firms in an industry have
essentially the same quality resources, use
the same technology, and compete for the
same laborers in the same labor market,
then the industry’s demand curve for labor
is the same as the individual firm’s demand
curve for labor, magnified by the number of
firms in the industry.
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EXHIBIT 6
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INDUSTRY DEMAND FOR LABOR
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Exhibit 6: Industry Demand
for Labor
What is the firm’s demand for labor at
a wage rate of $20 compared to the
industry’s demand for labor at the
same wage rate?
• The firm’s demand for labor is 8 at a wage
rate of $20.
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Exhibit 6: Industry Demand
for Labor
What is the firm’s demand for labor at a
wage rate of $20 compared to the
industry’s demand for labor at the
same wage rate?
• With 1,000 firms in the industry, the
industry’s demand for labor at $20 =
(8 × 1,000) = 8,000 laborers.
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The Supply of Labor
The opportunity cost of working
—the value a laborer places on the
next best alternative to working—is
different for different people.
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The Supply of Labor
Opportunity cost determines how
many people are willing to work at
differing wage rates.
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EXHIBIT 7
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THE SUPPLY CURVE OF LABOR
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Exhibit 7: The Supply Curve
of Labor
Why does the labor supply curve
slope up in Exhibit 7?
• The curve is upward sloping because the
higher the wage rate, the more willing are
workers to supply greater quantities of labor.
Their opportunity costs are met at higher
wage rates.
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The Supply of Labor
Three factors affect workers’ willingness
to supply their labor at different wage
rates: changes in alternative
employment opportunities, changes in
population size, and changes in wealth.
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The Supply of Labor: Changes
in Alternative Employment
Opportunities
• When new industries willing to pay
higher wage rates enter a market, fewer
laborers are willing to work for the older
industry at the lower wage rate.
• The supply curve for labor in the older
industry shifts to the left.
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The Supply of Labor: Changes
in Population Size
• When the population of a region
declines, the number of workers
willing to work at any wage rate
declines.
• The supply curve for labor shifts to
the left.
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The Supply of Labor: Changes
in Wealth
• When people have more wealth,
they choose more leisure time and
less work.
• The supply curve for labor shifts to
the left.
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EXHIBIT 8
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CHANGES IN THE SUPPLY CURVE OF
LABOR
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Exhibit 8: Changes in the
Supply Curve of Labor
What happens to the quantity of
labor supplied at a wage rate of $20
when the supply curve shifts from
S to S ?
1
• The quantity of labor supplied drops from
8,000 to 6,000.
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The Supply of Labor
An increase in the wage rate typically
induces workers to increase the
quantity of labor supplied, but only up
to a certain point.
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The Supply of Labor
After that point, an increase in the
wage rate results in less, not more,
labor supplied.
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EXHIBIT 9
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THE BACKWARD-BENDING SUPPLY CURVE
OF LABOR
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Exhibit 9: The BackwardBending Supply Curve of Labor
What is the wage rate at which the
laborer in Exhibit 9 decides to cut
back on the quantity of labor he is
willing to supply?
• The laborer is willing to increase the
quantity of labor supplied up to a wage rate
of $40.
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Exhibit 9: The BackwardBending Supply Curve of Labor
What is the wage rate at which the
laborer in Exhibit 9 decides to cut
back on the quantity of labor he is
willing to supply?
• Above $40, the laborer cuts back on hours
worked per week and gains more leisure
time.
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Exhibit 9: The BackwardBending Supply Curve of Labor
What is the wage rate at which the
laborer in Exhibit 9 decides to cut
back on the quantity of labor he is
willing to supply?
• To the laborer, the value of the leisure time is
greater than the extra income he could have
earned by working more hours.
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Deriving Equilibrium
Wage Rates
Combining the industry demand curve
for labor and the industry supply
curve for labor allows the industry
equilibrium wage rate to be derived.
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Deriving Equilibrium
Wage Rates
• Individual firms within the industry
have no influence on the market
wage rate.
• Firms must accept the market wage
rate and face a horizontal supply
curve for labor.
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EXHIBIT 10 THE LABOR MARKET
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Exhibit 10: The Labor Market
How is the level of the horizontal
labor supply curve for the firm in
panel b of Exhibit 10 determined?
• The level of the labor supply curve is equal
to the equilibrium wage rate of the industry
(W = $20).
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Explaining Wage Rate Differentials
How different opportunity costs of laborers
affect the supply curve of labor and how
differences in technology and the price of
goods produced by labor affect MRP help
explain why different wage rates exist in
different labor markets.
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EXHIBIT 11
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U.S.- MEXICO WAGE RATE DIFFERENTIALS
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Exhibit 11: U.S.- Mexico Wage
Rate Differentials
What are the factors that caused the
wage rate to decline in Texas in
Exhibit 11?
• Immigration from Chihuahua to Texas
increased the pool of laborers and thus shifted
Texas’ labor supply curve to the right.
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Exhibit 11: U.S.- Mexico Wage
Rate Differentials
What are the factors that caused the
wage rate to decline in Texas in
Exhibit 11?
• At the same time, relocation of factories from
Texas to the Chihuahua shifted Texas’
demand curve for labor to the left.
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Exhibit 11: U.S.- Mexico Wage
Rate Differentials
What are the factors that caused the
wage rate to decline in Texas in
Exhibit 11?
• An increase in the supply of labor and a
decrease in the demand for labor caused
the wage rate to decline in Texas.
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EXHIBIT 12 MEXICAN FOREIGN BORN POPULATIONS
IN THE UNITED STATES: LEGAL 1960–2006
POPULATION)
Source: U.S. Census Bureau, Working Paper No. 29, Historical Census Statistics on the Foreign-Born Population of the United States:
1850–1900, US Government Printing Office, Washington, DC, 1999. Data for 2000 and 2006 are from US Bureau’s Census 2000 and
American Community Survey 2006.
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Exhibit 12: Mexican Foreign Born
Populations in the United States:
Legal 1960–2006
Mexican immigration (legal) more
than doubled during the 1990s and
continued to increase into the
twenty-first century
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Explaining Wage Rate
Differentials
The supply curve of labor is affected
not only by the supply conditions in
the labor market, but also by the
government’s immigration policy.
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EXHIBIT 13 MEDIAN HOURLY PAY FOR SELECT EU
COUNTRIES: PRIVATE SECTOR
(AS PERCENT OF HOURLY PAY IN
DENMARK)
Source: FedEE Pay in Europe 2006 Report, shown in http://www.finfacts.com/Private/isl/PayinEurope.htm
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Exhibit 13: Median Hourly Pay for
Select EU Countries: Private
Sector
Substantial migrant flows from East
Europe to West Europe because of:
•
Basic EU policy of free movement of
population within the EU
•
Considerable East-West wage differentials
within the EU
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EXHIBIT 14 MIGRANT POPULATIONS AND PERCENT
OF TOTAL WORLD POPULATION: 2005
(THOUSANDS AND PERCENT)
Source: International Migration, 2006, United Nations, Department of Economic and Social Affairs, Population Division, 2006
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Exhibit 14: Migrant Populations
and Percent of Total World
Population: 2005
In 2005, an estimated 191 million
people representing three percent of
the world’s population lived outside
their country of birth.
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Exhibit 14: Migrant Populations
and Percent of Total World
Population: 2005
1.4 percent of the total population in
the less developed countries
migrated in 2005.
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Persisting Wage Differentials
Noncompeting labor markets
• Markets whose requirement for specific skills
necessarily excludes workers who do not
have the required skills.
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Persisting Wage Differentials
Specific talents, limited to small
numbers of people, create unique
labor markets that allow relatively high
wage rates and protect wage rates
against erosion.
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The Economics of
Minimum Wage Rates
The problem with persistent wage
differentials is not so much that a few
people make millions, but that some
people are unable to compete
successfully in any occupation that
provides an adequate standard of
living.
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The Economics of
Minimum Wage Rates
In an effort to remedy the problem,
government can outlaw low wage rates
by implementing a minimum wage law.
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The Economics of
Minimum Wage Rates
• The problem with mandated minimum
wage rates is that employers cannot be
expected to hire workers whose MRP is
below the legislated minimum wage rate.
• Thus some workers are left with no job
at all.
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The Economics of
Minimum Wage Rates
The impact of minimum-wage
legislation on low-wage-rate-earning
people depends on the price elasticities
of demand and supply for labor.
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EXHIBIT 15 THE EFFECTS OF MINIMUM WAGE RATES
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Exhibit 15: The Effects of
Minimum Wage Rates
1. How many people lose their job
when minimum wage rates are
implemented under the price
elasticities of supply and demand
for labor in panel a?
• 1,000 workers were employed at $3 per hour.
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Exhibit 15: The Effects of
Minimum Wage Rates
1. How many people lose their job
when minimum wage rates are
implemented under the price
elasticities of supply and demand
for labor in panel a?
• Only 300 workers are employed at $5.15.
Thus 700 workers lose their jobs.
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Exhibit 15: The Effects of
Minimum Wage Rates
2. How many people lose their job
when minimum wage rates are
implemented under the price
elasticities of supply and demand
for labor in panel b?
• 1,000 laborers were employed at $3 per hour.
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Exhibit 15: The Effects of
Minimum Wage Rates
2. How many people lose their job
when minimum wage rates are
implemented under the price
elasticities of supply and demand
for labor in panel b?
• 9,000 laborers are employed at $5.15 per hour.
Thus only 100 lose their job.
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The Ethics of w = MRP
• Most economists accept marketdetermined wage rates as ethically
defensible.
• The ethic is expressed as “From
each according to his or her
contribution, to each according to
his or her contribution.”
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The Efficiency Wages Theory
Efficiency wages
• A wage higher than the market’s equilibrium
rate; a firm will pay this wage in the
expectation that the higher wage will reduce
the firm’s labor turnover and increase labor
productivity.
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The Efficiency Wages Theory
There are several reasons why a firm
may choose to pay efficiency wages:
• Efficiency wages increase workers’ morale and
motivation on the job.
• Efficiency wages allow the firm to select more
qualified workers.
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The Efficiency Wages Theory
There are several reasons why a firm
may choose to pay efficiency wages:
• Reduce labor turnover.
• Deter workers from joining unions.
• Fairness—if the firm is making a profit, it
should share some with its workforce.
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The Principal-Agent Problem
Principal-agent problem
• A problem that arises when either demander
or supplier in a labor market exercises an
undisclosed personal interest or motive that
undermines the efficacy of the market.
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