1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics by Fred M Gottheil

2 Chapter 15 Wage Rates in Competitive Labor Markets 4/17/2015 © ©1999 South-Western College Publishing

3 Turn from the product market to the factor (input or resource) market Roles of supply and demand are reversed: firms demand the factors, people supply them, as in the labor market Factor demand is a derived demand, that is, derived from the demand for the product being produced.

4 As in product market, different kinds of factor markets Begin with a perfectly competitive factor market, price of the factor is determined by supply and demand for the factor What is the profit maximizing quantity of a factor that a firm should use?

5 Here, we assume a competitive labor market Many buyers and sellers of labor Homogenous labor Perfect information and mobility

6 You already know a lot about the labor market Use marginal analysis, hire labor to the point where the added cost equals the added revenue

7 What is Marginal Physical Product? MPP is the change in output that results from adding one more unit of resource, such as labor, to production © ©1999 South-Western College Publishing

8 8 MPP = QLQL

9 What is Marginal Revenue Product? MRP is the change in total revenue that results from adding one more unit of a resource, such as labor, to production © ©1999 South-Western College Publishing

10 10 © ©1999 South-Western College Publishing MRP = MPP x P

11 11 © ©1999 South-Western College Publishing MRP = TR L

12 Calculation of MRP LaborOutputMPPPTRMRP 00$ $5$ $5$90$ $5$120$ $5$140$ $5$150$10

13 Why is the MRP Curve downward sloping? Due to the law of diminishing returns © ©1999 South-Western College Publishing

14 What is the Demand Curve for Labor? Same as the Laborer’s MRP curve © ©1999 South-Western College Publishing

15 M R P ( D e m a n d c u r v e ) W1 Q1 W2 Q2 15

16 What is Marginal Labor Cost? MLC is the change in a firm’s total cost that results from adding one more worker to production © ©1999 South-Western College Publishing

17 17 © ©1999 South-Western College Publishing MLC = TLC L

18 What is MLC equal to in a perfectly competitive labor market? The same as the market wage rate, that is, MLC = W (wage)

19 MRP MLC = W 1 W1W1 Q1Q1

20 How many people are hired to maximize profit? Up to and including the point where MRP = W © ©1999 South-Western College Publishing Why?

21 As long as MRP is greater than the wage rate, another worker will be hired because it is profitable to do so © ©1999 South-Western College Publishing

22 Why is profit made from hiring the last worker if MRP > W? Because that last worker adds more to total revenue than what that last worker is paid © ©1999 South-Western College Publishing

23 At what point will the last worker not be hired? That last worker will not be hired where MRP < W © ©1999 South-Western College Publishing

24 Why will the last worker not be hired where MRP < W? Because the last worker would cost more than what that last worker could add to total revenue © ©1999 South-Western College Publishing

25 Return to the table showing MRP calculation How many workers should this firm hire if the wage equals $20?

26 Calculation of MRP LaborOutputMPPPTRMRP 00$ $5$ $5$90$ $5$120$ $5$140$ $5$150$10

27 Answer: 4 workers, where MRP = W = $20

28 Shifts in the MRP curve, the firms demand curve for labor, can be caused by:  Changes in the product price  Changes in productivity of labor

29 Shift in Demand Curve D 1 =MRP 1 W Q 29 © ©1999 South-Western College Publishing D 2 =MRP 2

30 What is a Supply Curve for labor? A curve that shows how many units of labor will be supplied at various wages © ©1999 South-Western College Publishing

S W1W1 W2W2 Q1Q1 Q2Q2 Labor Wage

32 Why is the Supply Curve for Labor generally upward sloping? Because as the wage rate increases, more workers in the labor market will accept a job © ©1999 South-Western College Publishing

33 Difference between Market supply of labor and one individual’s labor supply  An individual’s labor supply curve might not always slope upward  Depends on the substitution and income effects of a wage change

34 Labor-Leisure trade off  Think of leisure as a product, we “buy” it by giving up labor, thus the price of leisure = wage given up  Thus higher wages raise the price of leisure, 2 possible effects to this

35  Substitution effect: higher wages raise the price of leisure, thus buy less leisure, work more  Income effect: higher wages raise income, thus demand more leisure ( a normal good), therefore work less  Shape of the Supply curve depends on strength of these 2, possible backward bending labor supply curve

36 Wage Labor W1 L1 UP TO W1, SUBSTITUTION EFFECT OUTWEIGHS INCOME EFFECT, WORK MORE DUE TO HIGHER WAGE ABOVE W1, INCOME EFFECT OUTWEIGHS SUBSTITUTION EFFECT, WORK LESS DUE TO HIGHER WAGE

37 What can cause a shift in the Supply Curve for Labor? Other opportunities Non-monetary aspects of a job Changes in size of the market © ©1999 South-Western College Publishing

38 S1 S2 W Q Shift in Supply 38

39 D S W3 Q3 W1 Surplus W2 Shortage 39 WAGES IN A FREE MARKET

40 Wage rate differentials Suppose wages for the same type of labor are higher in the north than the south, what tends to happen in the long run?

41  Labor tends to migrate north, decreasing labor supply in the south and increasing it in the north  Firms tend to migrate south, increasing labor demand in the south, decreasing it in the north  Net effect is to reduce the wage differential

42 Check out the Bureau of the Census at: cpsmain.htm © ©1999 South-Western College Publishing

43 What happens when the government imposes a minimum wage? The number of workers demanded is less than the number of workers supplied for low wage jobs © ©1999 South-Western College Publishing

44 D S W Unemployment The Minimum Wage 44

45 S W The Minimum Wage 45 D1D1 D2D2 wMwM

46 Note that the magnitude of the effect of the minimum wage depends on the elasticity of demand and supply of labor

47 For more information on the Minimum Wage: lic/minwage/main.htm © ©1999 South-Western College Publishing

48 What is the Efficiency Wage Theory? A firm may pay a wage higher than the market’s equilibrium wage in hopes of minimizing turnover and increasing productivity © ©1999 South-Western College Publishing

49 Elasticity of Demand for Labor ( or other factors of production)--depends on what? Elasticity of product demand, more elastic the demand for the product, the more elastic the demand for factors Importance in total cost, greater share of total cost a factor is, more elastic the demand Ease of substitution--easier to substitute for a factor, more elastic its demand it Time period, more elastic demand the longer the time period

50 50 © ©1999 South-Western College Publishing cmr/salcalc.html

51 What is Marginal Physical Product? What is Marginal Revenue Product? What is Marginal Labor Cost? What is the Law of Diminishing Returns?What is the Law of Diminishing Returns? Why is the Demand Curve for Labor negative?Why is the Demand Curve for Labor negative? Why is the Supply Curve for Labor upward sloping?Why is the Supply Curve for Labor upward sloping?

52 ENDEND © ©1999 South-Western College Publishing