Chapter Thirteen Labor Markets. 13 | 2 Copyright © Houghton Mifflin Company. All rights reserved....

Chapter Thirteen

Labor Markets

Copyright © Houghton Mifflin Company. All rights reserved. 13 | 2

The Labor Market

• The labor market, just like the goods market, can be represented using a labor supply and labor demand curve. One big difference between the labor market and the goods market however, is households are sellers in the labor market, while firms are buyers.

• Figure 13.1 illustrates a typical labor supply and labor demand curve.


The Labor Market (cont’d)Figure 13.1


Measuring Worker’s Pay

• Fringe benefits – Compensation that a worker receives excluding direct money payments for time worked; includes insurance, retirement benefits, vacation time, and sick leave.


• Wage – The price of labor defined over period of time; expressed as currency per unit of labor worked.

• Real wage – The wage or price of labor adjusted for inflation; in contrast, nominal wage has not been adjusted for inflation.

Adjusting for Inflation


• The real wage is computed by dividing the nominal wage by an index of prices. The most commonly used index for prices is the CPI.

Adjusting for Inflation (cont’d)

Real wage = nominal wage

CPI


Wage Trends

• Figure 13.2 shows the trend for the average real hourly wage in the United States from 1991 – 2004.

• The average wage in the US in 2004 (expressed in 1999 dollars) was about $22.23 per hour, which includes about $6.48 in fringe benefits.


Wage Trends (cont’d)

Figure 13.2


• From Figure 13.2, we can see that the US average hourly real wage fell between 1993-1994, but has risen dramatically between 1996-2002.



Other US labor market trends:

1) Workers with higher skills are paid more than unskilled workers and the gap is increasing.

2) College graduates earn more than high school graduates and the gap has been increasing.

3) Women are paid lower than men, although the gap has become more narrow over the years.



Labor Demand

• Labor Market – The market in which individuals supply their labor time to firms in exchange for salaries and wages.

• Labor Supply – The relationship between the quantity of labor supplied by individuals and the wage.


Labor Demand (cont’d)

• Labor Demand – The relationship between the quantity of labor demanded by firms and the wage. Labor demand is a derived demand.

• Derived Demand – The demand for an input derived from the demand for the product produced with that input.


A Firm’s Employment Decisions

Simple rule to follow when hiring a worker:

• If employing another worker increases the firm’s profits, then the firm will employ that worker.


• Marginal product of labor – The change in production due to a one-unit increase in the labor input.

• Marginal revenue product of labor = the change in total revenue due to a one-unit increase in the labor input.

• Table 13.1 illustrates an example showing how the marginal product and the marginal revenue product of labor is calculated.

A Firm’s Employment Decisions (cont’d)




• From Table 13.1, we can see that the marginal product of labor and the marginal revenue product of labor is calculated as:


MP = Change in Q

Change in L

MRP = Change in TR

Change in L


From Table 13.1, we observe that

1) The marginal product of labor is declining. This is because the firm is producing in the short run, and has a fixed capital input.

2) The marginal revenue product of labor is declining. Because the MRP = P X MP, then a decline in marginal product will result in a declining marginal revenue product as well.



MRP = Wage

• If a firm is profit maximizing, it will hire the largest number of workers for which the MRP is greater than the wage. If the firm can hire fractional units of labor, then the firm will continue to hire until the MRP = Wage.

• Note: At the point where the MRP equals the wage, the MRP must be downward sloping.


Intuition• If MRP of the next worker is greater than

the wage, hiring the next worker will bring more revenues than costs, so profits will increase.

• If MRP of the next worker is less than the wage, hiring the next worker will bring less revenues than costs, so profits will decrease.

MRP = Wage (cont’d)


The Firm’s Demand for Labor

• Because the firm will hire workers using the rule MRP = Wage, then the demand curve for labor is determined completely by the marginal revenue product of labor.

• Figure 13.3 illustrates how the labor demand curve is determined.


The Firm’s Demand for Labor (cont’d)Figure 13.3


• The derivation of the demand for labor using the marginal revenue product of labor (MRP) holds only when the firm has no market power. If a firm has market power, then the price of the good is no longer constant, and the rule of MRP = wage no longer applies.

• To best understand this point, we look at a sample firm with market power in Table 13.2.

What if the Firm has Market Power?


What if the Firm has Market Power? (cont’d)


• In Table 13.2, the firm has market power, as illustrated by the inverse relationship between the price of the good and the quantity.

• Note: In the calculation for marginal product, marginal revenue is the same for a competitive firm as it is for a firm with market power.




• The marginal revenue product of labor is still the change in the total revenue resulting from the hiring of one more unit of labor.

• The marginal revenue product of labor is no longer calculated as MRP = P X MP, because the price is not constant.

MRP = Change in TR

Change in L


Instead, the MRP is calculated as follows:

MRP = the marginal revenue times the marginal product of labor= MR X MP.

• Because the MR drops faster than the price, then the marginal revenue product of labor will fall faster in a firm with market power than in a competitive firm.



The Market Demand for Labor

• The market demand for labor is derived by the horizontal summation of the individual demand curves of the labor market.

• Figure 13.4 illustrates an example where the market demand for labor is derived from two firms. Note that the market demand curve is flatter than either of the individual demand curves.


The Market Demand for Labor (cont’d)Figure 13.4


Labor Supply

• In economics, the decision to supply labor is analyzed as a decision between working and the other activities that can be done instead of working.

• Leisure – Generic term used by economists for non-work activities.


Recall• Labor Supply – The relationship between

the quantity of labor supplied by individuals and the wage.

Labor Supply (cont’d)


Labor Supply (cont’d)

• Like the decision to consume a commodity, the decision to work more or less given a wage change can be analyzed with the concepts of the income effect and the substitution effect.


The Substitution Effect of a Wage Change

• The substitution effect states that the higher the hourly wage, the more attractive work will seem relative to the other activities. As a result, the quantity of work supplied will increase when the wage increases.


• The income effect reflects the effect of a wage change (remember, wage is the price of labor) on your real income.

• The income effect can either induce you to work more (if you consider leisure an inferior good) or to work less (if you consider leisure a normal good). Our discussion revolves only in leisure as normal goods, so an increase in income will make you work less.

The Income Effect of a Wage Change


The Income and Substitution Effect of a Wage Change

• An individual’s reaction to a change in the wage rate depends on the direction of the income effect, and the relative sizes of the income and substitution effect. Again, we assume that the income effect is negative, i.e., higher wages make you want to work less.


• The supply curve will be upward sloping if the income effect is smaller than the substitution effect.

• The supply curve will be downward sloping if the income effect is greater than the substitution effect (this is also known as the backward-bending labor supply curve).

• The supply curve will be vertical if the income effect equals the substitution effect.

The Shape of the Supply Curve


• Figure 13.5 illustrates the three possible shapes of the labor supply curve. Figure 13.6 summarizes the relative sizes of the income and substitution effects associated with the differing slopes of the labor supply curve.

The Shape of the Supply Curve (cont’d)


The Shape of the Supply Curve (cont’d)Figure 13.5


The Shape of the Supply Curve (cont’d)Figure 13.6


Work vs. Getting Human Capital

• Another alternative for working is getting more education and training in order to increase skills or human capital.

• Human capital – A person’s accumulated knowledge and skills.


• The decision to either work or “invest” on human capital is analyzed just like any other economic choice. To make the correct choice, we need to compare the benefits of investing in human capital with the benefits of not investing in human capital.

Work vs. Getting Human Capital (cont’d)


Analyzing the Decision of Going to College

• Benefits: College will improve skills and increase the probability of landing a higher paying job (higher pay).

• Costs: Forego earning income, pay tuition.

– You decide to go to college if you perceive the benefits are greater than the cost.



• On-the-job training is another way to increase worker’s productivity. Training can either be firm specific (learning a software that only your company uses) or general purpose (acquiring skills transferable to other jobs).

• On-the-job training – The building of skills of a firm’s employees while they work for the firm.



Higher Education and Success

• Figure 13.7 shows the mean earnings of workers classified based on gender, race and educational attainment. Based on the figure, we can conclude that higher educational attainment may increase average earning potential of workers.


Higher Education and Success (cont’d)Figure 13.7


Labor Market Equilibrium

• Labor market equilibrium – The situation in which the quantity of labor supplied equals the quantity of labor demanded; the point of intersection of the labor supply and the labor demand curve.


Labor Productivity

Labor productivity – Output per hour of work.

• Figure 13.8 illustrates the growth rate (in percent) of labor productivity (the bar graph) and the growth rate of real wages (the line graph) between 1990 – 2004.


Labor Productivity (cont’d)Figure 13.8


• Figure 13.8 shows a strong correlation between labor productivity and the real wage. When the growth rate of labor productivity is low, the real wages drop or rise slowly. When the growth rate of labor productivity is high, the real wages rise faster.

• This observation suggests that the growth rate of labor productivity is a major explanation for wage changes over time.

Labor Productivity (cont’d)


Compensating Wage Differentials

• Compensating Wage Differential – A difference in wage for people with similar skills based on some characteristics of the job, such as riskiness, discomfort, or convenience of time schedule. Compensating wage differentials are not based on the marginal product.


Discrimination• Discrimination – Not hiring workers even though their

marginal product is as high or exceeds other workers; may also be defined as paying a lower wage to a worker when the marginal product of labor of the worker is equal to or greater than that of other workers.

• Discrimination may be based on race, gender, or other observable differences in workers.

• The effects of discrimination on a firm is best illustrated in Figure 13.9.


Discrimination (cont’d)Figure 13.9


• From Figure 13.9, discrimination can be illustrated as an incorrect perception of a lower marginal revenue product for the discriminated worker. The lower perceived marginal revenue product will cause the firm to hire fewer of these discriminated workers and to hire them at a lower wage.

Discrimination (cont’d)


• From Figure 13.9, discrimination will lead to sub-optimal profits made by the firm. If the firm hired more of the workers it discriminated against, its profits would rise.

Discrimination (cont’d)


Minimum Wage Laws

• Minimum wage laws – A government legislation that requires that firms pay a worker a wage no lower than the legislated minimum. The minimum wage is effectively a price floor, where paying a wage lower than the floor is not legal.


Minimum Wage Laws (cont’d)

(Source: Department of Labor, Wage and Hour Division)

Minimum Wages of Some States (as of Jan. 2006):

Alaska - $7.15Alabama – no minimum wage lawArizona – no minimum wage lawCalifornia - $6.75 per hourColorado - $5.15 per hourConnecticut - $7.40 per hourFlorida - $6.40 per hourHawaii - $6.75 per hour


Minimum Wages of Some States (as of Jan. 2006):

Kentucky - $5.15Louisiana – no minimum wage law Massachusetts - $6.75 per hour.Michigan - $5.15Ohio - $4.25 ($3.35 if firm annual sales $150,000-500,000, $2.80 if firm sales less than $150,000)Texas - $5.15Washington - $7.35District of Columbia - $7.00


(Source: Department of Labor, Wage and Hour Division)


• Figure 13.10 illustrates the impact of a minimum wage law.

• Unemployment will arise if the minimum wage rate is higher than the market equilibrium. A minimum wage law will have no effect (market will be in equilibrium) if the minimum wage is set below market equilibrium.



Minimum Wage Laws (cont’d)Figure 13.10


Wage Payments and Incentives

• Piece - rate system – A system in which workers are paid a specific amount per unit of output that they produce.

Examples

1) Lettuce growers pay harvesters and packers per box of lettuce that they pack.

2) Cotton pickers are paid per 100 pounds of cotton that they pick.


• Deferred wage contract – An agreement between a worker and an employer where the worker is paid less than the marginal revenue product when young, and subsequently paid more than marginal revenue product when old.

• Example: Lawyers and Accountants get paid a lot more once they become partners.

Wage Payments and Incentives (cont’d)


Labor Unions

• Labor Union – A coalition of workers organized to improve wages and working conditions of members.

• Industrial union – A union organized within an industry. Whose members come from a variety of occupations.

• Craft union – A union organized to represent a single occupation, whose members come from a variety of industries.


• National Labor Relations Act (1935) – A law that gives workers the right to organize into unions and bargain with employers.

• National Labor Relations Board – The government agency that has been set up to make sure that firms do not illegally prevent workers from organizing and to monitor union election of officials.

Labor Unions (cont’d)


• One observation of industries with labor unions is that wages of union workers are higher than non-union workers.

• According to one theory, unions can raise wages by restricting labor supply. By restricting the supply of workers in the union, the supply of non-union workers increases and the equilibrium wages drop for non-union workers. This is illustrated in Figure 13.11.



Labor Unions (cont’d)Figure 13.11


• Another explanation why union wages are higher, is that unions can increase worker marginal productivity. Their argument goes like this:

• Consider a worker who identifies an opportunity to increase wages (say by providing better tools) and goes to management. Management might not choose to hear the worker if he is alone. However, the voice may be heard and implemented if a collection of workers go to management instead.



Monopsony and Bilateral Monopoly

• Monopsony – A situation in which there is a single buyer of a particular good or service in a given market.

• Bilateral monopoly – The situation in which there is one buyer and one seller in a market.


Key Terms

• Fringe benefits• Wage and real wage• Labor market• Labor demand and labor supply• Derived demand• Marginal revenue product of labor• Backward bending labor supply curve• Human capital


• On-the-job training• Labor market equilibrium• Labor productivity• Compensating wage differential• Piece-rate system• Deferred payment contract• Labor union• Craft union and industrial union• Monopsony and bilateral monopoly.

Key Terms (cont’d)

Date post:	18-Jan-2016
Category:	Documents
Upload:	stella-price
View:	219 times
Download:	1 times

Chapter Thirteen Labor Markets. 13 | 2 Copyright © Houghton Mifflin Company. All rights reserved....

Documents