All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 1

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 2 Labour and Wages CHAPTER 13

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 3 INTRODUCTION Cobb-Douglas production model that shows the relationship between inputs and outputs is formalized by a production function of the form Q = f (K,L,M), where Q represents the firm’s output of a particular good during a period. K represents capital. L represents labour input. M represents raw material.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 4 FOUR FACTORS OF PRODUCTION AND THEIR PAYMENTS Land - Rent Labour - Wages Capital - Interest Entrepreneurship - Profit

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 5 PAYMENT FOR FACTORS OF PRODUCTION When a new Information Technology (IT) college is set up to produce graduates for human capital specializing in IT, it needs lecturers to teach IT courses (mental labour), the physical space on which a college sit (land), a building, class room furniture and teaching enable classroom (capital), and the head of college or the CEO to manage the college (entrepreneurship).

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 6 Derived Demand Firm’s demand for factors of production derived from its decision to supply a good in another market. Joint Demand Production needs more than one factor of production. TYPES OF DEMAND FOR FACTORS OF PRODUCTION

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 7 THEORY OF MARGINAL PRODUCTIVITY The demand for a factor depends on its marginal revenue product. The greater the productivity of the factor, the greater will be the demand for that particular product, ceteris paribus.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 8 CONCEPTS IN MARGINAL PRODUCTIVITY Total Physical product (TPP): The total output produced by employing the factors of production. Marginal Physical Product (MPP): The additional of total product as a result of employing one more unit of a factor.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 9 Total Revenue Product (TRP): Total revenue gained by employing factors of production. Marginal Revenue Product (MRP): The additional total revenue as a result of employing one more unit of an input. It is also the demand curve of the factor and it is a downward sloping because of the law of diminishing return. CONCEPTS IN MARGINAL PRODUCTIVITY (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 10 Monopolistic competition: MRP = MPP X MR Perfect competition: MPP X P/AR/ MR Marginal value product (MVP): Marginal product of an input times the prices of the output. MVP = MPP X P CONCEPTS IN MARGINAL PRODUCTIVITY (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 11 DETERMINATION OF EQUILIBRIUM PRICE OF A FACTOR Labour markets are determined by the forces of demand and supply. The supply and demand for tomato pickers will determine the price wage and the number of tomato pickers.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 12 Panel (a) shows how the supply and demand for tomatoes determine the prices of tomatoes THE VERSATILITY OF DEMAND AND SUPPLY Supply and demand for tomato pickers determine the wage of the tomato pickers

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 13 Panel (b) shows how the supply and demand for tomatoes determine the wage of the tomato pickers THE VERSATILITY OF DEMAND AND SUPPLY (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 14 WAGES AND WAGE DIFFERENTIAL According to the Oxford Dictionary of Economics, wage is a payment for work performed by an employee. Wage differential is the difference in wage rates between two types of worker. It may be on account of different levels of skill, formal qualifications, between unionized and non- unionized firms, or between workers of different age, sex, or ethnic groups.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 15 CHANGE IN WAGE RATE Will change the motivation of individual to work longer hours. For example, with higher wage, people will agree to work overtime, less entertainment or leisure hours, or might retire later. Positively sloped and positive relationship between wage rate and labour supply.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 16 TERM OF WAGES Nominal wages refer to the wage or salary in terms of the particular currency of a country, in case of Malaysia is RM. Real wages refer to the purchasing power. For example, if a singer earns RM5000 for each concert, in terms of real wages it means how much the singer can purchase with that amount of income.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 17 DEMAND FOR LABOUR: THE MARGINAL PRODUCTIVITY THEORY Question: How many tomato pickers will be employed by the owner? The firm will answer this question by weighing up the costs of employing an extra labour against the revenue. In the labour markets, the firm will maximize profits where the marginal cost of hiring an extra worker equals the marginal revenue that the worker’s output earns for the firm.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 18 The profit-maximizing approach MC labour = MR labour DEMAND FOR LABOUR: THE MARGINAL PRODUCTIVITY THEORY (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 19 MEASUREMENT OF MARGINAL COST AND REVENUE OF LABOUR Marginal factor cost (MFC L ): The amount an additional unit of variable unit (L) adds to the total cost. Marginal revenue of labour (MRP L ): The amount an additional unit of the variable input (L) adds to total revenue. MFC L =  Q TC/  L MFL L = MPP L X MP Q

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 20 OPTIMAL USE OF VARIABLE INPUT (L) The optimal level occurs at the point where the marginal benefits are equal to the marginal costs.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 21 THE PROFIT MAXIMIZING LEVEL OF EMPLOYMENT FOR A FIRM The profit maximizing level is at point a.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 22 THE PROFIT MAXIMIZING LEVEL OF EMPLOYMENT FOR A FIRM (CON’T) Average and marginal physical product

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 23 DERIVATION OF THE FIRM’S DEMAND CURVE FOR LABOUR Wage rate at three different levels

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 24 FACTORS THAT AFFECT THE POSITION OF THE DEMAND FOR LABOUR Wage rate Productivity of labour Demand for the good

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 25 DERIVATION OF THE INDUSTRY DEMAND CURVE FOR LABOUR When more workers are being employed, the total industry output will increase, and hence P (and MR) will be pushed down

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 26 LABOUR SUPPLY Labour is provided to labour markets by individuals who choose among available employment opportunities. A rational individual will refuse to work long hours, take early retirement and choose to work freelance.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 27 UTILITY MAXIMIZATION A person maximizes utility by choosing H* hours of leisure and consumption of C*

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 28 THE OPPORTUNITY COST OF LEISURE People have to bear the cost for each hour they do not work and it should be the real wage. Real wage is that people can turn their earnings into actual consumer goods.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 29 INCOME EFFECT OF A CHANGE IN THE REAL WAGE Income Effect (IE): A rise in wage tends to increase leisure. Since leisure is a normal good, the higher income resulting from a higher w increases the demand for it.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 30 SUBSTITUTION EFFECTS OF A CHANGE IN THE REAL WAGE (CON’T) Substitution Effect (SE): Effect of increase in w on the hours of leisure is to reduce it. As leisure becomes more expensive, there is reason to consume less of it.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 31 Figure 13.7 illustrates two different reactions to an increase in w EFFECT OF AN INCREASE IN WAGE RATE

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 32 MARKET SUPPLY CURVE FOR LABOUR Labour supply curves will always have positive slopes if people are willing to assume that in most substitution effects of wage changes will be more important than income effects. SE>IE