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Labor Market Equilibrium Copyright©2004 South-Western 18 EQUILIBRIUM IN THE LABOR MARKET • The wage adjusts to balance the supply and demand for labor. • The wage equals the value of the marginal product of labor. Copyright © 2004 South-Western Figure 4 Equilibrium in a Labor Market Wage (price of labor) Supply Equilibrium wage, W Demand 0 Equilibrium employment,L Quantity of Labor Copyright©2003 Southwestern/Thomson Learning EQUILIBRIUM IN THE LABOR MARKET • Labor supply and labor demand determine the equilibrium wage. • Shifts in the supply or demand curve for labor cause the equilibrium wage to change. Copyright © 2004 South-Western Figure 5 A Shift in Labor Supply Wage (price of labor) 1. An increase in labor supply . . . Supply,S S W W 2. . . . reduces the wage . . . Demand 0 L Quantity of Labor 3. . . . and raises employment. L Copyright©2003 Southwestern/Thomson Learning Shifts in Labor Supply • An increase in the supply of labor : • • • • • • Results in a surplus of labor. Puts downward pressure on wages. Makes it profitable for firms to hire more workers. Results in diminishing marginal product. Lowers the value of the marginal product. Gives a new equilibrium. Copyright © 2004 South-Western Figure 6 A Shift in Labor Demand Wage (price of labor) Supply W 1. An increase in labor demand . . . W 2. . . . increases the wage . . . D Demand, D 0 L Quantity of Labor 3. . . . and increases employment. L Copyright©2003 Southwestern/Thomson Learning Shifts in Labor Demand • An increase in the demand for labor : • • • • Makes it profitable for firms to hire more workers. Puts upward pressure on wages. Raises the value of the marginal product. Gives a new equilibrium. Copyright © 2004 South-Western What is the Effect ofWhy a Minimum Wage?wage is minimum likely to reduce employment? Wage (price of labor) Supply Wmin Equilibrium wage, W How MUCH … depends on the elasticity of demand for Demand labor. Why? 0 Lmin Equilibrium employment,L Quantity of Labor Copyright©2003 Southwestern/Thomson Learning Who Pays for Health Insurance? Who PAYS?! Wage (price of labor) Worth $2 Supply Why? Equilibrium wage, W Benefits Costs $2 Demand Wages 0 Equilibrium employment,L Quantity of Labor Copyright©2003 Southwestern/Thomson Learning What do unions do? Wage (price of labor) If workers are more skilled, they have higher MPs. Supply W* Equilibrium wage, W Demand 0 Equilibrium employment,L Quantity of Labor Copyright©2003 Southwestern/Thomson Learning What do unions do? Wage (price of labor) If workers are no more skilled, Increased W unemployment Supply W* What happens To total wages, W*L*? A> It depends on the elasticity of demand Equilibrium wage, W Demand 0 L* Equilibrium employment,L Quantity of Labor Copyright©2003 Southwestern/Thomson Learning What happens during epidemics? Wage (price of labor) Labor Suppl y FALLS Equilibrium wage, W Result: Eq’m Output Eq’m wage or Supply BUT Labor Demand also FALLS Demand 0 Equilibrium employment,L Quantity of Labor Copyright©2003 Southwestern/Thomson Learning Table 2 Productivity and Wage Growth in the United States. Copyright©2004 South-Western What causes productivity increase? • Physical capital More (better) machines to work with. • Human capital More education. More experience. Better training. Copyright © 2004 South-Western OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL • Physical Capital refers to the equipment and structures used to produce goods and services. • The economy’s capital represents the accumulation of goods produced in the past that are being used in the present to produce new goods and services. Copyright © 2004 South-Western OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL • Prices of Land and Capital • The purchase price is what a person pays to own a factor of production indefinitely. • The rental price is what a person pays to use a factor of production for a limited period of time. Copyright © 2004 South-Western Equilibrium in the Markets for Land and Capital • The rental price of land and the rental price of capital are determined by supply and demand. • The firm increases the quantity hired until the value of the factor’s marginal product equals the factor’s price. Copyright © 2004 South-Western Figure 7 The Markets for Land and Capital (a) The Market for Land Rental Price of Land (b) The Market for Capital Rental Price of Capital Supply P Supply P Demand Demand 0 Q Quantity of Land 0 Q Quantity of Capital Copyright©2003 Southwestern/Thomson Learning Equilibrium in the Markets for Land and Capital • Each factor’s rental price must equal the value of its marginal product. • They each earn the value of their marginal contribution to the production process. P x MPPlabor = wage P x MPPcapital = capital rent P x MPPland = land rent Copyright © 2004 South-Western Equilibrium in the Markets for Land and Capital P x MPPlabor = wage P x MPPcapital = capital rent for example, P = capital rent/MPPcapital capital rent/MPPcapitalx MPPlabor = wage MPPlabor /MPPcapital = wage /capital rent Ratio of Mgl Products = Ratio of factor prices So if daily wage is $100, and daily rental is $500, what can we say about ratio of Mgl Products? A> MPPlabor /MPPcapital = 100/500 Copyright © 2004 South-Western Equilibrium in the Markets for Land and Capital MPPlabor /MPPcapital = wage /capital rent Ratio of Mgl Products = Ratio of factor prices MPPlabor / wage = MPPcapital /capital rent Bang/$ = Bang/$ If Bang/$ for laborers is GREATER than for machines, what do we do? Why? Copyright © 2004 South-Western Linkages among the Factors of Production • Factors of production are used together. • The marginal product of any one factor depends on the quantities of all factors that are available. • A change in the supply of one factor alters the earnings of all the factors. Copyright © 2004 South-Western Linkages among the Factors of Production • A change in earnings of any factor can be found by analyzing the impact of the event on the value of the marginal product of that factor. Copyright © 2004 South-Western Summary • The economy’s income is distributed in the markets for the factors of production. • The three most important factors of production are labor, land, and capital. • The demand for a factor, such as labor, is a derived demand that comes from firms that use the factors to produce goods and services. Copyright © 2004 South-Western Summary • Competitive, profit-maximizing firms hire each factor up to the point at which the value of the marginal product of the factor equals its price. • The supply of labor arises from individuals’ tradeoff between work and leisure. • An upward-sloping labor supply curve means that people respond to an increase in the wage by enjoying less leisure and working more hours. Copyright © 2004 South-Western Summary • The price paid to each factor adjusts to balance the supply and demand for that factor. • Because factor demand reflects the value of the marginal product of that factor, in equilibrium each factor is compensated according to its marginal contribution to the production of goods and services. Copyright © 2004 South-Western Summary • Because factors of production are used together, the marginal product of any one factor depends on the quantities of all factors that are available. • As a result, a change in the supply of one factor alters the equilibrium earnings of all the factors. Copyright © 2004 South-Western