The Demand for Labor • The model of supply and demand can be used to study the determination of wages and employment in the labor market. Firms use workers to produce products demanded by consumers. Economists say that labor demand is a derived demand, that is, derived from the demand for the products produced by workers.
Labor Demand by anIndividual Firm in the Short-Run • The firm will pick the quantity of labor at which the marginal benefit of labor equals the marginal cost of labor. Marginal PRINCIPLEIncrease the level of an activity if its marginal benefit exceeds its marginal cost; reduce the level of an activity if its marginal cost exceeds its marginal benefit. If possible, pick the level at which the activity’s marginal benefit equals its marginal cost.
Labor Demand by anIndividual Firm in the Short Run PRINCIPLEof Diminishing ReturnsSuppose output is produced with two or more inputs and we increase one input while holding the other input or inputs fixed. Beyond some point—called the point of diminishing returns—output will increase at a decreasing rate.
The Marginal Principlefor Labor Decision Because of diminishing returns, the marginal product of labor (the change in output from one additional worker) decreases as the number of workers increases.
The Marginal Principlefor Labor Decision The marginal benefit of labor equals the marginal revenue product of labor (MRP).
Labor Demand by an Individual Firm in the Short Run • The marginal revenue product of labor (MRP) is the extra revenue generated from one more unit of labor; equal to price of output times the marginal product of labor.
The Marginal Principle andthe Firm’s Demand for Labor Using the marginal principle, the firm picks the quantity of workers at which the marginal benefit (the marginal revenue product of labor) equals the marginal cost (the wage).
The Marginal Principle andthe Firm’s Demand for Labor • Because the marginal product drops as the numbers of workers increases, the MRP curve is negatively sloped.
The Marginal Principle andthe Firm’s Demand for Labor • The MRP curve (or marginal benefit curve) is also the firm’s short-run demand curve for labor.
The Marginal Principle andthe Firm’s Demand for Labor • The short-run demand curve for labor is a curve showing the relationship between the wage and the quantity of labor demanded over the short run, the period when the firm cannot change its production facility.
The Marginal Principle andthe Firm’s Demand for Labor • At an hourly wage of $8, marginal revenue product equals marginal cost when the firm hires five workers.
The Marginal Principle andthe Firm’s Demand for Labor • If the wage goes up to $11 an hour, the firm hires 3 workers.
The Marginal Principle andthe Firm’s Demand for Labor • The additional revenue from the 6th worker is less than the $8 additional cost of that worker.
The Marginal Principle andthe Firm’s Demand for Labor • If you pick a wage, the MRP curve tells you exactly how much labor the firm will demand.
An Increase in the Price of OutputShifts the Labor Demand Curve • An increase in the price of the output or in productivity will shift the entire labor demand curve to the right.
What About LaborDemand in the Long Run? • The long-run demand curve for labor is a curve showing the relationship between the wage and the quantity of labor demanded over the long run, when the number of firms in the market can change and firms already in the market can modify their production facilities.
What About LaborDemand in the Long Run? • Although there are no diminishing returns in the long run, the market demand curve is still negatively sloped for two reasons: • The output effect: The change in the quantity of labor demanded resulting from a change in the quantity of output produced. • The input-substitution effect: The change in the quantity of labor demanded resulting from a change in the relative cost of labor.
Short-Run Versus Long-Run Demand • The demand for labor is less elastic (steeper) in the short-run than in the long run (flatter), because in the short run the firm has less flexibility to substitute other inputs for labor or modify its production facilities.
The Individual Decision:How Many Hours? • An increase in the wage—the price of labor—has the following effects on the demand for leisure: • Substitution effect: As the wage increases, a worker will substitute income for leisure time • Income effect: An increase in the wage increases the worker’s real income and the demand for leisure time
The Market Supply Curve • The market supply curve for labor shows the relationship between the wage and the quantity of labor supplied.
The Market Supply Curve • The market supply curve for labor is positively sloped, consistent with the law of supply: The higher the wage (the price of labor), the larger the quantity of labor supplied.
Supply, Demand,and Market Equilibrium • At the market equilibrium (point e, with wage = $15 per hour and quantity = 16,000 hours), the quantity supplied equals the quantity demanded.
Supply, Demand,and Market Equilibrium • There is neither excess demand for labor nor excess supply of labor.
Supply, Demand,and Market Equilibrium • An increase in the wage affects the quantity of nursing supplied in three ways: • Change in hours per worker. • Occupational choice. • Migration. The second and third effects reinforce one another, so an increase in the wage causes movement upward along the market supply curve.
Market Equilibrium • A market equilibrium is a situation in which there is no pressure to change the price of a good or service. Equilibrium occurs at point e where the supply curve intersects the demand curve.
Market Equilibrium • Equilibrium wage is $15 per hour and the equilibrium quantity is 16,000 hours of nursing per day. At this wage, there is neither excess demand for labor nor excess supply of labor.
Market Effects of anIncrease in Demand for Labor • An increase in the demand for nursing services shifts the demand curve to the right, moving the equilibrium from point e to point f.
Market Effects of anIncrease in Demand for Labor • The equilibrium wage increases from $15 to $17 per hour. The equilibrium quantity increases from 16,000 hours to 19,000 hours.
Why Do WagesDiffer Across Occupations? • The wage for a particular occupation will be high if the supply of workers in that occupation is small relative to the demand for those workers.
Why Do WagesDiffer Across Occupations? • If supply is low relative to demand–because few people have the skills, training costs are high, or the job is undesirable–the equilibrium wage will be high.
Why Do WagesDiffer Across Occupations? The supply of workers in a particular occupation could be small for four reasons: • Few people with the required skills. • High training costs. • Undesirable job features. • Artificial barriers to entry.
Why Do College GraduatesEarn Higher Wages? • In 1997, the typical graduate earned 78% more than the typical high-school graduate. There are two reasons for the college premium: • The learning effect: The increase in a person’s wage resulting from the learning of skills required for certain occupations. • The signaling effect: The increase in a person’s wage resulting from the signal of productivity provided by completing college.
Effects of the Minimum Wage • The minimum wage decreases the quantity of labor employed and yields good news and bad news for workers, employers and consumers: • Good news: Some workers keep their jobs and earn a higher wage. • Bad news: Some workers lose their jobs, and production costs rise, increasing the price of goods and services.
The Market Effectsof the Minimum Wage • The market equilibrium is shown by point e. The wage is $4.70 per hour, and the quantity of labor is 50,000 labor hours per day.
The Market Effectsof the Minimum Wage • A minimum wage of $5.15 per hour decreases the quantity of labor demanded to 49,000 hours per day.
The Market Effectsof the Minimum Wage Although some workers receive a higher wage, others lose their jobs or work fewer hours.
Occupational Licensing • Occupational licensing has been criticized on three grounds: • Weak link between performance and licensing requirements. • Alternative means of protection. • Entry restrictions.
The Market Effects ofOccupational Licensing • To be a licensed pharmacist, a worker can complete a 5-year baccalaureate or a 6-year doctorate. The market equilibrium with this educational requirement is shown by point e.
The Market Effects ofOccupational Licensing • Occupational licensing increases the cost of entering an occupation, shifting the supply curve to the left.
The Market Effects ofOccupational Licensing • An increase in the required education for pharmacists increases the equilibrium wage from $15 to $17.
The Market Effects ofOccupational Licensing • The equilibrium quantity decreases from 32,000 to 24,000 hours of labor.
Labor Unions • A labor union is an organized group of workers: the objectives of the organization are to increase job security, improve working conditions, and increase wages and fringe benefits.
A Brief History of Labor Unionsin the United States • There are two types of labor unions: • A craft union includes workers from a particular occupation, for example, plumbers, bakers, or electricians. • An industrial union includes all types of workers from a single industry, for example, steelworkers or autoworkers.
Unionization Ratesin the United States, 1999 • Overall, 14% of all wage and salary workers are members of unions. Over 37% of public-sector workers are members of unions.
Labor Unions and Wages • Three approaches to increase the wages of union workers: • Organize workers and negotiate a higher wage—restricting membership. • Promote the products produced by union workers; labor demand is derived demand. • Increase the amount of labor required to produce a given quantity of output—a practice known as “featherbedding.”
Imperfect Informationand Efficiency Wages • There is asymmetric information in the labor market because employers cannot distinguish between skillful and unskillful workers, or between hard workers and lazy workers. If the employer cannot distinguish between different types of workers, it will pay a single wage, realizing that it will probably hire workers of each type.
Imperfect Informationand Efficiency Wages • To attract some high-skill workers, the employer must pay a wage that exceeds the opportunity cost of high-skill workers. Paying efficiency wages is the practice of a firm paying a higher wage to increase the average productivity of its workforce. As the firm attracts more skilled workers, the average productivity of the workforce rises. By paying efficiency wages to increase the average productivity of its workforce, a firm could increase its profit.
Monopsony Power • A monopsony is a single buyer of a particular input. • A monopsonist faces a positively sloped market supply curve of labor. • If the monopsonist hires more workers, it must pay a higher wage to attract them away from other activities.