Economics 200 -- Introduction to Microeconomic Analysis

Professor Steven C. Hackett

Humboldt State University

Lecture Outlines

Labor Markets

Reading: Chapter 11 of Tucker

Overview:

 

The Labor Market Under Perfect Competition

 

In perfectly competitive markets we assume that there are many small buyers and sellers (no one of which can influence market price through its output choices), that sellers offer essentially homogeneous goods or services, and that entry is nearly costless.

 

In labor markets the firms are the buyers, workers are the sellers, and the service being exchanged is labor. The price of labor is the prevailing pay rate per hour.

 

Labor markets are usually highly specialized based on the type of labor and on location. Thus there is an entry-level labor market in Arcata, California, that is different from that of Redding or San Francisco.

 

Usually the higher skill or responsibility associated with the job description, the more geographically dispersed is the labor market. Thus, for example, the market for research electrical engineers, neurosurgeons, professors, and CEO's is regional, state-wide, national, or even international in scope, and searches are usually national or sometimes international in scope. The labor market for school teachers, retail store managers, and shift foremen may be local or regional in scope, and county-wide, multi-county, or occasionally state-wide searches are common. The market for retail clerks, restaurant wait-staff, auto mechanics, and maintenance workers is usually local in scope.

 

A perfectly competitive labor market means that the market has many workers willing and able to supply similar types of skills (and many firms with willingness-to-pay for labor), and entry is nearly costless.

 

Demand for Labor

 

Firms are the source of demand for labor. Profit-maximizing firms demand labor when hiring more labor will increase profitability.

 

Thus to develop the demand for labor we have to understand the marginal productivity of labor, and the marginal revenue product generated by labor

 

Consider the following short-run example for the production of cabinets in a custom cabinet shop. Assume that each cabinet wholesales for $50. To keep the example simple we are ignoring capital:

 

Points

(1) Labor input (workers per day)

(2) Total output per day

(3) Marginal product per day =

D(2)/D(1)

(4) Product price

(5) Marginal revenue product = (3) x (4)

---

0

0

---

 

 

A

1

10

10

$50

$500

B

2

18

8

$50

$400

C

3

24

6

$50

$300

D

4

28

4

$50

$200

E

5

30

2

$50

$100

 

Definition: The marginal revenue product of labor is the change in total revenue caused by the employment of an additional unit of labor. It can be computed in two ways:

 

MRPL = DTR/DL             where TR is total revenue and L is labor employed

 

MRPL = MPL  x P            where MPL marginal product of labor and P is price

 

Take a moment and confirm that you can derive the data in column (5) of the table above using both of these formulas.

 

 

IMPORTANT QUESTION: Why does MRP decline as more and more labor is employed in the short run?

 

 

Suppose that the market wage rate for skilled cabinet workers is $430 per day. Is it profitable for the firm to hire the first worker at $430 per day? Yes, because the worker adds $500 in revenue to the firm. Is it profitable to hire the second worker? No, because the second worker only adds $400 in revenue to the firm. Thus when the wage is $430/day, the quantity of labor demanded QDL = 1.

 

Now suppose that the market wage rate for skilled cabinet workers is $340 per day. How many workers is it profitable for the firm to employ? What is QDL when the price of labor is $340/day?

 

Now suppose that the price of labor is $260 per day. How many workers is it profitable for the firm to employ? What is QDL when the price of labor is $260/day?

 

Now suppose that the price of labor is $140 per day. How many workers is it profitable for the firm to employ? What is QDL when the price of labor is $140/day?

 

What do we call the relationship between P and QD? Is the MRPL the firm's demand curve for labor? Why?

 

 

IMPORTANT QUESTION: What would cause the firm's demand for labor to increase (shift outwards to the right)? What would cause the firm's demand for labor to decrease?

 

 

The demand for labor is a derived demand because firms only demand labor because consumers demand the goods and services produced by labor. Thus the demand for labor derives from the demand for the goods and services produced by labor.

 

Workers who are highly skilled, and thus highly productive (output per hour) are said to possess more human capital than those who are less skilled and productive.

 

 

Supply of Labor

 

Workers supply labor. As with the supply of goods and services, opportunity cost is a key element of the supply of labor. Different workers have different opportunity costs. Why? How does one's productivity and education affect a worker's opportunity cost? How does a lack of mobility (inability to move) affect a worker's opportunity cost?

 

Ceteris Paribus, relatively few workers are willing to supply labor (QSL is low) at low wages or salaries. The reason is that workers have an opportunity cost. For example, they can move to another area and access better wages elsewhere. When the market wage for a particular type of job is below most workers' opportunity cost who consider themselves in that occupation, few will enter the labor market at that wage.

 

As the market wage rises for a particular occupation, then ceteris paribus, the QSL rises, just like a regular supply curve.

 

As wages continue to rise, some full-time workers may decide to "moonlight" in a second part-time job. For example, a school teacher might moonlight as a textbook proof-reader in the evening if a textbook publisher is paying $100 per hour for those services. She might not moonlight, however, if they are only paying $15 per hour.

 

 

IMPORTANT QUESTION: Does the law of increasing opportunity cost exist for workers? Why? If so, how does this law affect the shape of an individual's labor supply curve?

 

 

Equilibrium in the Competitive Labor Market

 

Draw supply and demand for labor and derive the equilibrium wage rate in the competitive market for labor.

 

Draw a representative small employer diagram beside the market diagram. Show the supply of labor as a horizontal line at the prevailing market wage rate.

 

 

 

IMPORTANT QUESTION: Suppose that there is an international labor market for highly skilled researchers. Suppose that the Czech Republic spends $5 billion in education and training of its domestic researcher labor force. How will this affect the demand for Czech researchers? If in the short run the supply of researcher labor in the Czech Republic is fixed, how will this affect the equilibrium wage rate for these researchers? Draw supply and demand for labor and show impacts.

 

Labor Unions

 

Labor unions formed to improve workplace safety, shorten weekly work hours, provide for retirement, health, and unemployment benefits, etc.

 

Labor unions also work at improving the economic circumstances of its membership. They do so in several ways.

 

1. Unions work to increase the demand for labor:

 

·        Require firms to hire more workers than necessary.

·        Encourage consumers to buy "made in the USA" products.

·        Encourage consumers to buy union-made products.

·        Train and improve the skills of union workers.

 

2. Unions work to decrease the supply of labor:

 

·        Long apprenticeships.

·        Limit immigration.

·        Shorter workweeks.

 

 

Draw diagram showing increased demand and decreased supply of labor and impacts on wages. Discuss political economy of unions serving the interests of senior members over entry-level workers.

 

3. Unions use collective bargaining to raise wages above the market equilibrium level. Unintended consequence: increased unemployment.