Lecture Outlines - Week 4

The Labor Market (Ch 8 Schiller)

Labor Supply: The willingness and ability to work specific amounts of time at alternative wage rates in a given time period, ceteris paribus.

There are a variety of different factors that affect how many hours per week that someone is willing and able to work, including family budget crises, wage, opportunity cost, etc.

What is the opportunity cost of working an additional hour? You give up the various benefits of non-work time, which the book describes as "leisure" but is more generally the set of child-rearing activities, house work, maintenance, family, friend, and community support, volunteerism, etc., as well as true "leisure."

For example, if you are a teacher, you might consider moonlighting as a waiter at a restaurant at night, or as a house painter in the summer. What desirable or beneficial non-work activities do you give up in order to work? That answer is the opportunity cost of supplying additional labor.

Suppose that you already work a 40-hour week, but you are considering accepting a contract to produce Internet content. What hourly rate would you set for your time?

Now suppose that you already work a 60-hour week, but you are considering accepting a contract to produce Internet content. What hourly rate would you set for your time?

Why is it that as you work more and more hours, the opportunity cost of working an additional hour becomes larger and larger?

-As hours worked rises, the time available for all non-job activities (housecleaning, childrearing, grocery shopping, rest, recreation) declines. At first you might give up non-job activities that you don't care about very much. But as the time available for all non-job activities continues to shrink, eventually you are having to give up increasingly important non-job activities.

Thus there is generally a positive relationship between hourly earnings and the quantity of labor supplied.

Is the idea of paying workers "overtime" pay of time-and-one-half for working more than 8 hours per day, or more than 40 hours per week, consistent with an upward-sloping labor supply curve?

Labor Demand:

Why do employers hire workers? Because they add value of some sort. The demand for labor is derived from the demand for the final goods and services produced by the firm.

Thus, for example, the demand for an accountant at GM is ultimately derived from the demand for GM cars and trucks, and the value that the accountant contributes to the process of creating these cars and trucks.

For a profit-maximizing firm, ultimately the value added by a worker is measured as revenue. The decision regarding employment of a worker hinges on whether the revenue added by that worker exceeds the wage paid to the worker.

Definition: Marginal Physical Product (MPP) is the additional output produced by the employment of an additional unit of labor.

MPP = (Additional Output)/(Additional Unit of Labor)

Definition: Marginal Revenue Product (MRP) is the additional revenue produced by the employment of an additional unit of labor.

MRP = (Price of Final Good or Service) x MPP.

EXAMPLE: Suppose an accountant can produce 3 completed tax returns on average each day, and her company charges $200 for each completed tax return. Then her MPP = 3 per day, and her MRP = $600 per day.

If MRP > Wage, then employment of that worker will raise profit. Why?

CONCEPT: Law of Diminishing Marginal Returns: The MPP of labor tends to decline as more and more labor is hired. Why? In the short run there is only so much land and capital available. In other words, in the short run land and capital have a fixed quantity, and can only be varied in the long run (that's how long run and short run are defined in economics). Therefore, eventually a firm can hire so much labor that congestion occurs in the short run.

For example, consider Smugs Pizza on G Street in Arcata. As the amount of labor employed increases, very quickly workers run out of room to make pizzas, and thus their MPP declines. Suppose that each Smug's pizza is sold for $10. Then let the table below illustrate MPP, MRP, and diminishing marginal returns to labor:

If the Arcata labor market is such that pizza shop workers are paid an equilibrium wage of $6.50 per hour for a 10-hour shift, then daily pay at Smugs is $65. As a profit-maximizer, how many workers will Smugs hire? Why?

Draw the picture. Link to figure 8.4 in Schiller.

Labor Market:

How do we get the market labor demand curve? Like with the demand for goods and services, we horizontally sum quantity demanded at each wage. For example, suppose there are four employers in the labor market (A-D). Then at a wage of $7 per hour, quantity demanded by firm A might be 50, and 20 by firm B, and 30 by firm C, and 100 by firm D. Then at a $7 hourly wage, market quantity demanded is equal to 50+20+30+100 = 200. Repeat at higher or lower wages to get the market labor demand schedule.

Likewise, we horizontally sum each individual worker's labor supply curve to get the market labor supply curve.

The equilibrium wage occurs where labor supply and demand intersect.

Draw the picture. Link to figure 8.5 in Schiller.

Suppose the worker productivity in some occupation rises, so that MPP and MRP both increase. How is this revealed in the labor market for this occupation? What happens to equilibrium wages? Explain.

Public Policy Issues:

1. Minimum Wage: What is the intended effect? What are the unintended side effects? Is there a better way to help the working poor?

2. Labor Unions: Start with a labor market equilibrium. What can a labor union do to raise wages?

• Reduce the supply of union labor--costly worker qualification standards, long apprenticeships, seniority preferences. This will also tend to increase the supply of nonunion labor, thereby depressing nonunion wages.
• Increase the demand for union labor--education and training to raise union worker quality, "closed-shop" work rules, promote union-made goods and services.