Principles of Microeconomics Lecture 6: Labour markets (and economic rent!)

Overview Demand for labour Supply of labour Marginal productivity theory of income distribution Why do wages differ? Economic rent

Demand for labour The ‘consumers’ of labour are employers (which we normally associate with supply) Labour is an example of ‘derived demand’ I.e. Demand for a factor of production that is used in (and derived from the demand of) another product A quick recap: MPL

Demand for labour Again, remember about decision-making at the margin, increasing additional units until MC = MB But what is the MB of labour? Marginal revenue product of labour (MRPL): The revenue generated by hiring an additional (‘the next’) worker And the MC? The wage (w) paid to the worker

Demand for labour Thus, employers will continue to demand workers whilst MRPL > w, until MRPL = w Note, these figures are usually different for each firm and market! The aggregation of these firm-level decisions is illustrated in the demand for labour …just as demand curves in other markets are simply derived from individual conceptions of MC > MB (to the point at which MC = MB)

Demand for labour MRPL > w MRPL < w MRPL = w The firm should hire more workers to increase profits MRPL < w The firm should hire fewer workers to increase profits MRPL = w The is hiring the optimal number of workers and is maximising profits

Note: All of these factors change MRPL ! Demand for labour Shifts in demand for labour are caused by: Changes in human capital Changes in technology Changes in the price of the product the labour is being used to produce Change in quantity of other inputs to production (usually K) Changes in the number of firms in the market Note: All of these factors change MRPL !

Supply of labour The suppliers of labour are workers The supply of labour curve is strange - it eventually bends backwards! Why? As the wage increases, eventually the supply of labour will reduce because the worker will prefer (and can afford) more leisure In a sense it is a bit like a rotated TR curve…

Supply of labour

Supply of labour However it’s more technical than that… Income effect: As income , workers can now afford more leisure (which is at least a normal good for most people!) Substitution effect: As the wage , the opportunity cost of leisure increases, thus increasing the amount of labour supplied

Supply of labour Income effect is dominant Substitution effect is dominant

Supply of labour Shifts in supply for labour are caused by: Changing size of population (n) Changing demographics Changes in alternative labour markets

Equilibrium employment (L*) Putting it together… Wage (w) ($ per hour) Quantity of labour (L) Supply of labour (SL) Demand for labour (DL) Equilibrium wage (w*) Equilibrium employment (L*)

Marginal productivity theory of income distribution The theory: Every factor of production that is sold in a factor market is paid its equilibrium value of its marginal product E.g. Labour is paid a wage equal to the MRPL of the last unit of labour sold the market However, it only works in perfectly competitive factor markets

Why do wages differ? Differences in MRPL ‘Compensating differentials’ E.g. A movie star v. cleaner ‘Compensating differentials’ E.g. wages of Australian expats in Papua New Guinea v. Australian wages Discrimination Employers who discriminate bear an economic penalty Relative market power Related to the concept of economic rent…

Why do wages differ? SAust. movie stars DAust. movie stars SCleaners ($ per year) Quantity of labour SAust. movie stars ?? $millions 10 ? DAust. movie stars $25,000 DCleaners SCleaners 40,000

Economic rent Economic rent is the payment to a factor of production (L, K, T) beyond what is required to bring that factor into the market The additional income received (the ‘rent’) is unearned, in the sense that it not earning a return due to any kind of entrepreneurship Factors of production that earn pure economic rent are in fixed supply [e.g., certain kinds of natural resources]

Note: It is different to producer surplus in that it is paid to a factor of production Pure economic rent