How Wages Are Set

The Circular Flow Model Revisited If no $ is going from the factor market to the household, then there is no $ to buy the product

Circular Flow Model Product Market $ $ Firms Households $ $ Factor Market

The Circular Flow Model Revisited If no $ is going from the factor market to the household, then there is no $ to buy the product Also, if the $ is too little to the household, then they cannot afford the product in the market

Circular Flow Model Product Market FINISHED GOODS PRODUCT PURCHASE Firms Households UNFINISED GOODS Factor Market LABOR

The Circular Flow Model Revisited If no $ is going from the factor market to the household, then there is no $ to buy the product Also, if the $ is too little to the household, then they cannot afford the product in the market Relative to the price of a finished product, a firm will not pay a worker more than the value of a finished product

Diminishing Returns Firms do not always have the time or ability to update their machines or the buildings they operate in

Diminishing Returns Firms do not always have the time or ability to update their machines or the buildings they operate in As a result, the only way to increase production is by adding more workers and raw materials

Diminishing Returns Firms do not always have the time or ability to update their machines or the buildings they operate in As a result, the only way to increase production is by adding more workers and raw materials At some point, they will reach a limit to their facilities, and will not be able to produce anymore

Diminishing Returns Firms do not always have the time or ability to update their machines or the buildings they operate in As a result, the only way to increase production is by adding more workers and raw materials At some point, they will reach a limit to their facilities, and will not be able to produce anymore This concept is diminishing returns

Diminishing Returns Following the same example, with each additional worker added, you will produce fewer and fewer additional products

Diminishing Returns Following the same example, with each additional worker added, you will produce fewer and fewer additional products This concept is known as diminishing marginal productivity

Diminishing Returns Following the same example, with each additional worker added, you will produce fewer and fewer additional products This concept is known as diminishing marginal productivity Ex. – with 5 workers the firm makes 100 items per day (20)

Diminishing Returns Following the same example, with each additional worker added, you will produce fewer and fewer additional products This concept is known as diminishing marginal productivity Ex. – with 5 workers the firm makes 100 items per day (20) With 6 workers the firm makes 118 items per day (19.6), with 7, 132 (18.85)

Diminishing Returns Supply of Workers

Diminishing Returns Supply of Workers The higher the average wage, the more people that will be willing to look for work

Diminishing Returns Supply of Workers The higher the average wage, the more people that will be willing to look for work This concept is known as labor force participation rate

Diminishing Returns Supply of Workers The higher the average wage, the more people that will be willing to look for work This concept is known as labor force participation rate If we were to graph this rate on a chart with diminishing marginal productivity, we would be able to fined the equilibrium wage rate

Number of Workers and Jobs Demand for Labor Equilibrium Wage Rate Wage Rate Supply of Workers Number of Workers and Jobs

Diminishing Returns Supply of Workers The higher the average wage, the more people that will be willing to look for work This concept is known as labor force participation rate If we were to graph this rate on a chart with diminishing marginal productivity, we would be able to fined the equilibrium wage rate This is the point where the number of jobs and workers are the same, thus setting the wage rate

Diminishing Returns Comparing Wage Rates

Diminishing Returns Comparing Wage Rates When looking at wages over a time period, you need to keep two things in mind

Diminishing Returns Comparing Wage Rates When looking at wages over a time period, you need to keep two things in mind Money wages – are the actual amount of money that one receives for their labor

Diminishing Returns Comparing Wage Rates When looking at wages over a time period, you need to keep two things in mind Money wages – are the actual amount of money that one receives for their labor Real wages – refers to how much your money will buy