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The Labor Market

The Labor Market

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The Labor Market

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  1. The Labor Market

  2. Product Markets • Markets in which firms sell goods and services to households or other firms • Products made from the economy’s resources

  3. Factor Markets • Markets in which resources are sold to firms • Resources include • Capital, land, labor, and natural resources • Resources are sometimes called factors of production

  4. S S D D Households Firms Figure 1: Product and Factor Markets Product Markets Demand for Goods and Services Supply of Goods and Services Supplyof Resources Demand for Resources Factor Markets

  5. Labor Markets in Particular • Determining a worker’s wage rate • Groups of economic decision makers come together in markets in order to trade • Each decision maker tries to maximize something and faces constraints • Observe equilibrium price determined in those markets • Explore how various changes affect that equilibrium price

  6. Special Meaning • The special meaning of the price in the labor market—the wage rate • Income people earn over their lifetime will determine how they will be able to provide for themselves and their families • Adds a special moral dimension to events in labor markets

  7. Defining a Labor Market • How broadly or narrowly we define a market depends on the specific questions we wish to answer • Broadly defined markets may look at markets that draw on labor from all over the world • Narrowly defined markets may look at markets that draw on labor on a very localized level

  8. Competitive Labor Markets • Market with many indistinguishable sellers of labor and many buyers • Involves no barriers to entry or exit • Perfectly competitive labor markets must satisfy three conditions • Great many buyers (firms) and sellers (households) of labor in market • All workers in market appear the same to firms • No barriers to entering or leaving labor market

  9. Firms in Labor Markets • Sometimes firms that compete in the same product market also compete in the same labor markets, but • Some firms that compete in the same product market operate in different labor markets • Some firms that operate in different product markets compete in the same labor market • The demand side of a labor market includes all firms hiring labor in that labor market • These firms may (but not necessarily) compete in the same product market

  10. Derived Demand • The demand for labor is a derived demand―it arises from, and will vary with—the demand for the firm’s output • The phrase “will vary with” is important • The demand for labor by a firm will change whenever demand for the firm’s product changes

  11. Resource Demand: A General Rule • Marginal approach to profit • Firm should take any action that adds more to its revenue than it adds to its cost • When we view firm as a buyer in a resource or factor market, we use same principle of marginal decision making • This time action under consideration is “increase employment of the resource by another unit” • Rule becomes • Increase employment of any resource whenever doing so adds more to revenue than it adds to cost • To avoid confusion between decisions about resources and decisions about output, we don’t use terms “marginal revenue” and “marginal cost” when discussing factor markets • To track changes on the revenue side, use term “marginal revenue product”

  12. Marginal Revenue Product (MRP) • The change in firm’s total revenue divided by change in its employment of a resource • When firm thinks about changing resource by one unit at a time • MRP is the change in the firm’s revenue when it employs one more unit of the resource

  13. Marginal Factor Cost (MFC) • To track changes on the cost side, we use the term marginal factor cost • The MFC tells us the rise in cost per unit increase in the resource • When Δ Quantity of Resource = 1 MFC is increase in cost from employing one more unit of resource

  14. Marginal Approach to Profit • To maximize profit firm should increase its employment of any resource whenever MRP > MFC • But not when MRP < MFC • Profit-maximizing quantity of any resource is quantity at which MRP = MFC • If MRP >MFC, employing more of resource increases revenue more than cost • Profit will rise • When MRP <MFC, using more of resource adds more to cost than to revenue • Profit falls • When firm exploits every opportunity to increase profit it will arrive at the point at which MRP =MFC

  15. The Firm’s Employment Decision When Only Labor Is Variable • The Firm’s MRP in a Competitive Product Market • When output is sold in a competitive product market • MRP for any change in employment will equal price of output (P) times marginal product of labor (MPL) • MRP = P x MPL • The Firm’s MFC in a Competitive Labor Market • When labor is hired in a competitive labor market, MFC for any change in employment will equal market wage rate (W) • MFC = W

  16. The Profit-Maximizing Employment Level • Marginal approach to profit • A firm should take any action that adds more to its revenue than to its cost • Hire another worker when MRP > W, but not when MRP < W • To maximize profit, the firm should hire the number of workers such that MRP = W • Where the MRP curve intersects the wage line

  17. Dollars $200 1. Hiring another worker adds more to revenue . . . 150 3. until profits are maximized at five workers. 100 50 2. than it adds to cost . . . 1 2 3 4 5 6 7 8 Number of Workers Figure 2: The Profit-Maximizing Employment Level 60 MFC = Wage MRP

  18. The Two Approaches to Profit Maximization • Two different approaches for the firm to follow to maximize profit • MR and MC approach to find profit-maximizing output • MRP and MFC approach to find profit-maximizing employment • Can these two approaches lead to different decisions? • No, because these two “different” approaches are actually the same method viewed in two different ways • Remember that hiring another worker increases the firm’s output and therefore changes both its revenue and its cost • Whenever MRP > MFC for a change in employment, MR > MC for associated rise in output • Whenever MRP < MFC for a change in employment, MR < MC for associated rise in output • If MRP = MFC for a change in employment, MR = MC for associated change in output

  19. The Firm’s Labor Demand Curve • When labor is the only variable input, downward-sloping portion of MRP curve is firm’s labor demand curve • Tells us how much labor firm will want to employ at each wage rate

  20. Dollars Number of Workers Figure 3: The Firm’s Labor Demand Curve Firm's Labor Demand Curve A W1 W1 B W2 W2 MRP n1 n2

  21. The Firm’s Employment Decision When Several Inputs are Variable • Whether the firm can vary just labor, or several inputs simultaneously • Optimal level of employment will satisfy the MRP = W rule • Firm’s labor demand curve will slope downward • Decrease in wage rate will cause an increase in employment

  22. Dollars Number of Workers Figure 4:The Employment Decision with Several Variable Inputs A W1 W1 B C W2 W2 Firm' Labor Demand Curve MRP MRP n1 n2 n3

  23. The Market Demand For Labor • Market Labor Demand Curve • Indicates total number of workers all firms in a labor market want to employ at each wage rate • Found by horizontally summing across all firms’ individual labor demand curves

  24. Firm A Firm B Firm C Hourly Wage Hourly Wage Hourly Wage At any wage rate(such as $10) . . . and by Firms B, C, and all other firms as well . . . if we add the number of workers demanded by Firm A . . . Number of Workers Figure 5/b/c: The Market Demand For Labor $12 10 ld ld ld 80 100 40 50 30 90

  25. Labor Market Hourly Wage we get the market quantity of labor demanded at that wage rate. Number of Workers Figure 5d: The Market Demand For Labor $12 10 LD N2 = 80 + 40 + 30 + …. N1 = 100 + 50 + 90 + …

  26. Typical Firm Labor Market Hourly Wage Hourly Wage A B A B $10 n1 n2 N1 N2 Number of Workers Number of Workers Figure 6: A Shift in the Labor Demand Curve

  27. Shifts in the Market Labor Demand Curve • A change in any variable that affects quantity of labor demanded—except for the wage rate—causes labor demand curve to shift • Specific variables that shift the labor demand curve include a change in • Demand for the firm’s product • Technology • Prince of another input • Number of firms

  28. A Change in Demand for the Firm’s Output • Effect of a change in output price on labor demand depends on whether many firms in the labor market also share the same product market • When they do • A rise in output price will shift market labor demand curve rightward • A fall in output price will shift market labor demand curve leftward

  29. A Change in Technology • Complementary Input • An input whose utilization increases marginal product of another input • Substitute Input • An input whose utilization decreasesmarginal product of another input

  30. A Change in Technology • When many firms in a labor market acquire a new technology, the market labor demand curve will shift • Rightward if technology is complementary with labor • Leftward if technology is substitutable for labor

  31. Hourly Wage More of a Substitutable Input More of a Complementary Input Number of Workers Figure 7: Introducing a New Input

  32. A Change in the Price of Another Input • When price of some other input decreases, market labor demand curve may shift • Rightward if the input is complementary with labor • Leftward if the input is substitutable for labor

  33. Individual Labor Supply • Individuals as wage takers • No single labor seller can affect the market wage • In a competitive labor market • Each seller is a wage taker • He or she takes market wage rate as given

  34. The Income-Leisure Trade-off • Wage rate determines exact nature of the income-leisure trade-off • Higher the income »» higher the expense of leisure time

  35. The Labor Supply Decision • Individuals who are able to choose their own hours may • Choose optimal combination of income and leisure • Individuals who are not able to choose their own hours • Only make the choice of whether to offer their labor in a particular market or not

  36. Reservation Wages • Lowest wage rate at which an individual would supply labor to a particular labor market • When wage rate in a market exceeds an individual’s reservation wage for that market • Individual will decide to work there

  37. Market Labor Supply • Curve indicating the number of people who want jobs in a labor market at each wage rate • The higher the wage rate, the greater the quantity of labor supplied

  38. (a) (b) Hourly Hourly Wage Wage Number of Workers Number of Workers Figure 8: The Market Labor Supply Curve D $12 C 10 $10 1,000 1,200 1,000 1,800

  39. Shifts in the MarketLabor Supply Curve • A market labor supply curve will shift when • Something other than a change in wage rate causes a change in number of people who want to work in a particular market • Factors causing a labor supply curve to shift include • Change in market wage rate in other labor markets • Changes in cost of acquiring human capital • Number of qualified people • Changes in tastes

  40. A Change in the Market Wage Rate in Other Labor Markets • As long as some individuals can choose to supply their labor in two different markets • A rise in wage rate in one market will cause a leftward shift in labor supply curve in other market

  41. Changes in the Cost of Acquiring Human Capital • An increase in the cost of acquiring human capital will shift the labor supply curve leftward • A decrease in the cost of acquiring human capital will shift the labor supply curve rightward

  42. Number of Qualified People • Population growth causes labor supply curves in both national and local labor market to shift rightward over time • Labor supply curves can also shift due to migration within a country • If new people entering a field exceeds number of retirees in that field • Increase in supply results

  43. Changes in Tastes • Different types of jobs attract different people with different tastes • Danger and excitement vs. safety and routine • Women entering the workforce • Social contribution to community

  44. Short-Run vs. Long-Run Labor Supply • Short-run • Labor supply response to a wage-rate change comes from those who already have skills and geographic location needed to work in a market • Long-run • Labor supply response to a wage-rate change comes from those who will acquire skills and move into geographic location needed to work in a market

  45. Short-Run vs. Long-Run Labor Supply • Long-run labor supply curve indicates how many (qualified) people will want to work in a labor market • After full adjustment to a change in the wage rate • Long-run labor supply response is more wage elastic than short-run labor supply response

  46. 2. When the wage rate rises to $40, employment rises to 60,000 in the short run. Hourly Wage 1. Initially, the wage is $25 and 30,000 people supply labor. 3. In the longrun, the wage rate of $40 attracts new entrants and employment rises to 90,000. 4.The long-run labor supply curve connects points A and C. Number of Workers Figure 9: The Long-Run Labor Supply Curve . $40 B C A 25 30,000 60,000 90,000

  47. Labor Market Equilibrium • Supply and demand will drive a competitive labor market to its equilibrium point • Point where the labor supply and labor demand curves intersect

  48. Labor Market Typical Firm Hourly Dollars Wage 3. hires up to where its MRP curve crosses the $20 wage line. 2. Each law firm, taking the market wage of $20 as a given, Number of Paralegals 1. The market labor supply and labor demand curves determine the equilibrium wage rate and equilibrium employment. Figure 10: Labor Market Equilibrium LS $24 $20 W 20 LD 16 ld 2,000 3,000 4,500 10

  49. What Happens When Things Change? • Events that can cause labor demand curve and labor supply curve to shift include • Change in labor demand • Change in labor supply • Labor shortages and surpluses

  50. A Change in Labor Demand • In short-run, shift in labor demand moves along a short-run labor supply curve • In long-run, resulting increase in wage rate will cause short-run labor supply curve to shift also