Questions: (1) Where do the labor demand and supply curves come from? (2) How well do they explain the facts?
12_01WAGE (PRICE OF LABOR)
QUANTITY OF LABOR
Labor demand
Market wage
Amount of labor where quantity of labor supplied equals quantity of labor demanded
Labor supply
The Slowdown in Wage Growth12_02
INDEX,1992 = 100
110
100
90
80
70
601960 1965 1970 1975 1980 1985 1990 1995 2000
Real wage
High growthtrend
Low growthtrend
Two sides of the labor market: Firms and Workers
• Labor Demand – The firm’s decision
• Labor Supply – The worker’s decision
Derived Demand for Labor
• Labor demand is a derived from firm’s profit maximization decisions
• Firm chooses output to maximize profits (MC = P)
• This amount of output implies a level of labor input (short run)– a production function all over again
Market power? Not yet, let’s first start with competition
• A firm in a competitive market for its good: takes price as given
• But now also assume that the labor market is competitive: firm takes wage as given
Example: Competitive Firm with P = $100 (T12.1)
Workers Quantityproduced
MarginalProduct
TotalRevenue
MarginalRevenueProduct
0 0 -- 0 --1 17 17 1700 17002 31 14 3100 14003 42 11 4200 11004 51 9 5100 9005 58 7 5800 700
To derive the labor demand curve, first plot MRP by hand
Marginal Revenue Product Equals Wage
• Condition for Profit Maximization
• In symbols: MRP = W
• For firms in competitive markets:– MRP = PxMP– example 1700 = 100x17 or 1400 = 100x14
• This implies that MP = W/P– Marginal product of labor equals real wage
To get market demand for labor, sum up firms’ demands for labor
12_04
WEEKLY WAGE (DOLLARS)
WEEKLY WAGE (DOLLARS)
WEEKLY WAGE (DOLLARS)
1,500 1,500 1,500
1,000 1,0001,000
500 500 500
50 0 010 5 10 5 10 15 20
QUANTITY OF LABOR (NUMBER OF WORKERS)
QUANTITY OF LABOR (NUMBER OF WORKERS)
QUANTITY OF LABOR (NUMBER OF WORKERS)
LABOR DEMAND IN THE MARKETLABOR DEMAND AT CAREERPROLABOR DEMAND AT GETAJOB
What if firm has market power as in a monopoly?
• Still must have MRP = W
• But in this case MRP does not equal P=MP– because P is not fixed– P must decrease as L and Q go up
Derivation of Labor Supply
• analogy with earlier analysis of consumer behavior: purposeful choices (work versus “leisure”) with limited resources (only 24 hrs in a day)
• The “price of leisure” is the opportunity cost of not working = wage
• As the wage rises, the price of leisure rises– thus the person will work more
“Leisure” includes school!
• Investing in human capital
• more human capital increase marginal product of a worker
Substitution versus income effect in labor supply
• Recall the two effects for a good– the two effects go in the same direction
• in case of labor supply the two effects go in opposite directions– hence labor supply can slope down!!!!!!!
3 different labor supply curves
12_05
WAGE WAGE WAGE
Labor supply
Labor supply
Labor supply
QUANTITY OF LABOR QUANTITY OF LABOR QUANTITY OF LABOR
INCOME EFFECT DOMINATESSUBSTITUTION EFFECT EQUALS INCOME EFFECT
SUBSTITUTION EFFECT DOMINATES
Backward bending labor supply curve
12_06
WAGE
LABOR SUPPLY
Substitution effect dominates in this region.
Income and substitution effects balance out.
Income effect dominates in this region.
A Test: compare trend in labor productivity with trend in real
wage12_07
INDEX,1992 = 100
110
100
90
80
Labor productivity
70
60
50
1960 1965 1970 1975 1980 1985 1990 1995 2000
High growthtrend
Low growthtrend
But productivity theory does not explain everything
• Compensating wage differentials– salaries in the business school versus the
economics department
• “Efficiency” Wages
• Long Term Employment Contracts– wage is related to productivity over long
periods, but not short periods
Effects of Minimum Wage12_09
Quantity of labor demanded
Quantity of labor supplied
Minimum wage
Labor market equilibrium
Labor demand
Labor demand
Labor supply
Labor supply
WAGEWAGE
QUANTITY OF LABORQUANTITY OF LABOR
Surplus
Market for Unskilled Workers Market for Skilled Workers
Discrimination in competitive markets
12_08 WAGE
Labor supply
Actual marginal revenue product
NUMBER OF WOMEN WORKERS
4. Because actual marginal revenue product is higher than the wage, other firms can hire these women at a higher wage but still below the marginal revenue product.
1. Prejudiced firm acts as if marginal revenue product is lower than it actually is.
2. Discrimination causes wages to fall by this amount.
3. Discrimination also causes lower employment for women.
Effects of Labor Unions12_10
WAGE WAGE
New labor supply
New labor supply
Old labor supply
Old labor supply
QUANTITY OF LABOR QUANTITY OF LABOR
Labor demand Labor demand
5. lowering the nominal wage.
3. and reducing employment in this market.
2. raisingthewage...
1. The union shifts supply to the left...
Market for Union Workers Market for Nonunion Workers
4. Workers from the union sector come to this sector, shifting supply to the right and...