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The Labor Market

The Labor Market. Product Markets. Markets in which firms sell goods and services to households or other firms Products made from the economy’s resources. Factor Markets. Markets in which resources are sold to firms Resources include Capital, land, labor, and natural resources

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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

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