Microeconomics 2 John Hey. Lecture 26: The Labour Market The supply of labour (consumer: leisure time/money trade-off). The demand for labour (theory.

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Presentation transcript:

Microeconomics 2 John Hey

Lecture 26: The Labour Market The supply of labour (consumer: leisure time/money trade-off). The demand for labour (theory of the firm). Equilibrium. Minimum wage legislation. Two questions for you: Does an increase in the wage rate imply an increase in the supply of labour? Is it therefore a good idea to reduce income tax (Mrs T and next lecture) Is minimum wage legislation a Good Thing? (old? Labour) Last year there was no question on this chapter in the examination. This year there will be.

The supply of labour We use the analysis of Chapter 6 (“Supply and Demand with income in the form of endowments”) The space: (l,m) l: leisure time in hours (Initially L=24 hours) m: money (to spend on) consumption (Initial holding M – could be zero) w: is the wage rate per hour Budget constraint is m = M +w(L-l) The supply of labour = L-l...depends upon the preferences. Obviously both money/consumption and leisure time are desirable (both are goods). Let us go to Maple…

The demand for labour We use the analysis of Chapters 11, 12 and 13 (Theory of the Firm/Production). We use a space with L d (the demand for) labour on the horizontal axis and the Cost and total Revenue of the firm on the vertical axis. We keep things simple by assuming that we are in the short run (capital fixed) with fixed costs equal to 5, and the wage fixed at 1 per unit. Total costs are fixed costs plus labour costs (linear in labour). The slope is the wage rate. Total revenue is the price of output multiplied by the output produced and so is concave. The slope of this curve is the price of output multiplied by the marginal product of labour.

Total revenue and costs Note crucially that the cost curve (the red line) is linear because the only variable input is labour (capital is fixed). Its slope is the wage rate w. The revenue curve is concave as capital is fixed and the rate at which revenue increases is the value of the marginal product of labour (which is decreasing as output goes up since capital is fixed). The slope of the revenue curve is the value of the marginal product of labour. Which (for a competitive firm) is equal to the price of output multiplied by the marginal product of labour. Let us go back to Maple...

The optimality condition for the demand for labour The slope of the total cost curve must be equal to the slope of the total revenue curve. The slope of the total cost curve is equal to the wage rate. The slope of the total revenue curve is equal to the price of output multiplied by the marginal product of labour. Hence the optimality condition: the real wage rate (the wage rate divided by the price of output) must be equal to the marginal product of labour.

A minimum wage? What happens in this market if the government introduces a minimum wage? Obviously at a level higher than the equilibrium wage in the competitive market.

Chapter 26 Goodbye!