Chapter 28

1. Chapter 28 The Labor Market: Demand, Supply, and Outsourcing

2. Introduction Since the mid-1990s, a number of U.S. firms, including International Business Machines (IBM) Corporation, have been engaging in outsourcing by hiring workers in foreign countries. Why are IBM and many other U.S. firms hiring workers abroad instead of here in the United States? In this chapter, you will learn the answer to this question.

3. Learning Objectives Understand why a firm’s marginal revenue product curve is its demand labor curve Explain in what sense the demand for labor is a “derived” demand Identify the key factors influencing the elasticity of demand for inputs

4. Learning Objectives (cont'd) Describe how equilibrium wage rates are determined for perfectly competitive firms Explain what labor outsourcing is and how it is ultimately likely to affect U.S. workers’ earnings and employment prospects Contrast the demand for labor and wage determination by a product market monopolist with outcomes that would arise under perfect competition

5. Chapter Outline Labor Demand for a Perfectly Competitive Firm The Market Demand for Labor Wage Determination in a Perfectly Competitive Market Labor Outsourcing, Wages, and Employment Monopoly in the Product Market The Utilization of Other Factors of Production

6. Did You Know That ... In Ukraine, when politicians want to have a large crowd at a political rally, they sometimes turn to a company called Easy Work, which pays college students to cheer for politicians? The demand for participants at political rallies by politicians can be studied in much the same manner as we studied the demand for output. A firm will hire employees up to the point at which the marginal benefit of hiring a worker will just equal the marginal cost.

7. Labor Demand for a Perfectly Competitive Firm We will start our analysis under the assumption that the market for input factors is perfectly competitive We will further assume that the output market is perfectly competitive This provides a benchmark against which to compare other labor markets or product markets that are not perfectly competitive

8. Labor Demand for a Perfectly Competitive Firm (cont'd) Assumptions Each employer is one of a very large number of employers Workers do not need special skills Workers are free to move from one employer to another The firm is a price taker in the labor market

9. Labor Demand for a Perfectly Competitive Firm (cont'd) Marginal Physical Product (MPP) of Labor The change in output resulting from the addition of one more worker The change in total output accounted for by hiring the worker, holding all other factors of production constant Eventually declines because of the law of diminishing marginal product

10. Labor Demand for a Perfectly Competitive Firm (cont'd) Marginal Revenue Product (MRP) The marginal physical product (MPP) times the marginal revenue (MR) The additional revenue obtained from a one-unit change in labor input The MRP represents the incremental worker’s contribution to the firm’s total revenues

11. Figure 28-1 Marginal Revenue Product, Panel (a)

12. Figure 28-1 Marginal Revenue Product, Panel (b)

13. Labor Demand for a Perfectly Competitive Firm (cont'd) Marginal Factor Cost (MFC) The cost of using an additional unit of an input For example, if a firm can hire all the workers it wants at the going wage rate, the MFC of labor is the wage rate. change in total cost Marginal factor cost = change in amount of resources used

14. Labor Demand for a Perfectly Competitive Firm (cont'd) In a perfectly competitive labor market The market determines the wage The individual employer is a wage taker All workers are hired for the same wage MFC = wage

15. Labor Demand for a Perfectly Competitive Firm (cont'd) General rule for hiring The firm hires workers up to the point at which the additional cost associated with hiring the last worker is equal to the additional revenue generated by hiring that worker

16. Labor Demand for a Perfectly Competitive Firm (cont'd) The MRP Curve: Demand For Labor The MRP curve is the demand curve for labor for the firm This tells us how many workers will be hired at various possible wage rates The firm will hire any worker who can contribute to revenues by more than they contribute to costs

17. Labor Demand for a Perfectly Competitive Firm (cont'd) Derived Demand Input factor demand derived from demand for the final product being produced The factors of production are needed to manufacture a final good or to provide a final service

18. Figure 28-2 Demand for Labor, a Derived Demand

19. The Market Demand for Labor The downward-sloping portion of each firm’s MRP curve is also its demand curve for labor When we go to the entire market for labor, we will also find that the quantity of labor demanded varies inversely with wage rate changes

20. Figure 28-3 Derivation of the Market Demand Curve for Labor • Wage rate of $20 • Firms will hire 2,000 workers • Wage rate of $10 • Firms will hire 3,000 workers

21. The Market Demand for Labor (cont'd) Price elasticity of demand for labor similar to elasticity for goods Percentage change in quantity demanded divided by percentage change in price of labor Inelastic < I Unit-elastic = 1 Elastic > 1

22. The Market Demand for Labor (cont’d) Determinants of Demand Elasticity for Inputs The price elasticity of demand for a variable input will be greater: The greater the price elasticity of demand for the final product The easier it is to employ substitute inputs The larger the proportion of total costs accounted for by the particular variable input The longer the time period available for adjustment

23. International Example: Globalization of Tasks and the Elasticity of U.S. Labor Demand Economist Mine Senses has found evidence that a shift toward using foreign labor to perform more tasks has boosted labor demand elasticities in the United States by at least 20 percent on average. Thus, greater ease of substitution of foreign labor for labor in the United States has increased elasticities of U.S. labor demand.

24. Wage Determination in a Perfectly Competitive Labor Market Having developed the demand curve for labor in a particular industry, let’s turn to the labor supply curve By adding supply to our analysis, we can determine the equilibrium wage rate that workers earn in an industry, such as in Figure 28-4 We can think in terms of a supply curve for labor that slopes upward in a particular industry

25. Figure 28-4 The Equilibrium Wage Rate and the Titanium Battery Industry

26. Wage Determination in a Perfectly Competitive Labor Market (cont’d) Reasons for labor demand curve shifts Change in demand for the final product Change in labor productivity Change in the price of related factors

27. Wage Determination in a Perfectly Competitive Labor Market (cont’d) A change in the demandfor the finalproduct that labor is producing will shift the market demand curve for labor in the same direction A change in labor productivity will shift the market labor demand curve in the same direction

28. Wage Determination in a Perfectly Competitive Labor Market (cont’d) A change in the price of a substituteinput will cause demand for labor to change in the same direction A change in the price of acomplimentaryinput will cause the demand for labor to change in the opposite direction

29. Wage Determination in a Perfectly Competitive Labor Market (cont’d) Labor supply curves may shift in a particular industry for a number of reasons: Change in wages in other industries Changes in working conditions Job flexibility

30. International Example: An Increase in the Demand for Services of Icelandic Translators Two recent events increased the derived demand for Icelandic translation services: In 2008 and 2009, Iceland’s banking crisis led European and U.S. customers of banks in that nation to seek financial and legal assistance, which in turn required translations of documents written in the Icelandic language. In 2010, Iceland’s Eyjafjallajökull volcano began to erupt, raising the demand for media coverage and thus the demand for Icelandic translators.

31. Labor Outsourcing, Wages, and Employment Outsourcing A firm’s employment of labor outside the country in which the firm is located

32. Labor Outsourcing, Wages, and Employment (cont'd) Outsourcing Some U.S.-based companies outsource labor to other countries. Some firms based around the globe outsource labor to the United States.

33. Figure 28-5 Outsourcing of U.S. Computer Technical-Support Services

34. Labor Outsourcing, Wages, and Employment (cont'd) Question How are U.S. workers affected by outsourcing? Answers If cheaper labor is available in other countries, this will dampen the demand for U.S. labor But as the volume of global commerce rises, there may be more of a demand by foreign firms to hire U.S. workers as well

35. Labor Outsourcing, Wages, and Employment (cont'd) Labor outsourcing by U.S. firms tends to reduce U.S. wages and employment Whenever foreign firms engage in labor outsourcing to the United States, however, U.S. wages and employment increase

36. Figure 28-6 Outsourcing of Accounting Services by Canadian Firms

37. Labor Outsourcing, Wages, and Employment (cont'd) Summing up the economic implications of outsourcing Even in the best of times, workers experience short-run ups and downs in wages and jobs. In the United States, after all, about 4 million jobs come and go every month.

38. Labor Outsourcing, Wages, and Employment (cont'd) Summing up the economic implications of outsourcing (cont’d) Outsourcing is a two-way street Labor outsourcing does not just involve U.S. firms purchasing the labor services of residents located abroad This phenomenon also entails the purchase of labor services from U.S. workers who provide outsourcing services to companies located in other nations

39. Labor Outsourcing, Wages, and Employment (cont'd) Summing up the economic implications of outsourcing (cont’d) Not all workers gain equally from the trade of outsourced labor services, and some people temporarily lose, in the form of either lower wages or reduced employment opportunities Nevertheless, specialization and trade of labor services through outsourcing generate overall gains from trade for participating nations, such as India, Canada, and the United States

40. Why Not … prohibit U.S. firms from outsourcing? Barring U.S. companies from engaging in international labor outsourcing likely would have two negative consequences for the U.S. economy: The equilibrium wages that U.S. firms would have to pay to obtain labor that they had previously outsourced would increase, which would boost their operating costs and thus the equilibrium prices for consumers. Other nations’ governments probably would respond by prohibiting their own companies from outsourcing to U.S. workers, resulting in a decrease in the demand for U.S. labor.

41. Monopoly in the Product Market Now, let’s assume that the firm sells its product in an imperfectly competitive market (we assume the firm purchases inputs under perfect competition still) In other words, we are considering output market structures of monopoly, oligopoly, and monopolistic competition For the remainder of the chapter, we simply refer to a monopoly situation for ease of analysis

42. Monopoly in the Product Market (cont'd) Constructing the monopolist’s input demand curve In reconstructing the demand schedule for an input, we must recognize that The marginal physical product falls because of the law of diminishing marginal product as more workers are added The price (and marginal revenue) received for the product sold also falls as more is produced and sold

43. Figure 28-7 A Monopolist’s Marginal Revenue Product, Panel (a)

44. Figure 28-7 A Monopolist’s Marginal Revenue Product, Panel (b)

45. Monopoly in the Product Market (cont'd) Question Why does the monopolist hire fewer workers? Answer The marginal benefit to the monopolist of hiring an additional worker is affected by the fact that the monopolist faces a reduction in the price charged on all units in order to be able to sell more of the product

46. The Utilization of Other Factors of Production (cont'd) Cost minimization To minimize total costs for a particular rate of production, the firm will hire factors of production up to the point at which the marginal physical product per last dollar spent on each factor is equalized

47. The Utilization of Other Factors of Production (cont'd) Cost minimization MPP of labor MPP of capital MPP of land = = Price of labor Price of capital Price of land

48. Policy Example: Payroll Regulations Spur the Hiring of Independent Contractors Recently, U.S. firms have been hiring more independent contractors relative to the number of full-time employees. The key reason is that the federal government has gradually been requiring firms to provide more benefits—overtime pay, family leave, and health benefits—for full-time employees. The resulting higher effective wage rate for full-time employees has push down their MMP/wage rate ratio relative to the ratio for independent contractors.

49. The Utilization of Other Factors of Production (cont’d) Profit maximization revisited MRP of labor = Price of labor (wage) MRP of land = Price of land (rent) MRP of capital = Price of capital (cost per unit of service)

50. You Are There: At Staples, the Demand for Robotic Inputs Is Increasing Warehouses operated by Staples, the office supply retailer, have used robots called the “Kiva bot” to transport items and work alongside human workers. Robotic technology has become more useful for smaller and smaller tasks that were previously performed only by humans. What will happen to the demand for human warehouse workers at Staples?