1 Labor Markets

2 Review and overview In this section we want to look at various environments in which suppliers and demanders of labor interact. When I use the term environment I mean two things: 1) does the demander and/or the supplier of labor have the ability to influence the wage in the market 2) does the demander of labor sell the output of labor in a market where they are a price taker or a price maker?

3 perfectly competitive labor market Let’s look at a labor market where 1) in the labor market players are wage takers 2) in the output market the players are price takers. We will talk about equilibrium. In general, equilibrium means no force for change. In this type of market we say that where S=D we have equilibrium.

4 Market Supply Q of labor Wage S The supply of labor in a market is upward sloping. This implies firms as a group must pay workers a greater amount to get a greater amount of workers. The reason for this is to induce workers to come to this market from other alternatives like jobs in other markets, other geographic reasons, or just to get folks to give up leisure.

5 Market supply 2 Who would come over to my yard today and rake leaves, trim the bushes around the house, and do other odd jobs if I paid you 50 cents an hour? No one, right? (It wouldn’t help your grade either!) But what if I paid $10 per hour? Some of you might quit flipping burgers and some of you might give up playing computer games. These are the types of reasons we think the supply of labor by people is upward sloping in a labor market.

6 Labor demand In the section on demand it was mentioned that the demand in the market is influenced by the number of firms in the market. Basically we saw that if the number of firms increased the demand would increase and if the number of firms fell the demand would fall. Here I want to enhance what has already been said by looking at how a market demand for labor curve is constructed. If we say there are only two firms, then at any wage, like W1, the market demand is simply the horizontal summation of each firm’s demand at that wage. Firm 1 Firm 2 Market c1 c2 W Q W Q W Q W1

7 perfectly comp.labor mkt. W Q D S W1 W* W2 Q1 Q* Q2 The equilibrium wage and quantity traded in the market are W* and Q*. WHY? At wages above W*, like W1 the Qs>Qd. The excess supply of labor has some suppliers taking lower wages in the hopes of selling their labor supply. At a wage lower than W*, like at W2, the excess demand created would have demanders bid up the price of labor in the hopes of being able to buy some labor.

8 Changes in equilibrium Equilibrium will change if supply changes demand changes some combination of the two. Here I want to focus on the mechanics.

9 Supply change W Q D S1 W1 Q1 S3 S2 Start at S1 and D, where the market is in equilibrium at W1 and Q1. The movement to S2 is an increase in supply. Note at W1 the dashed line out to the new supply. This represents the excess supply created by the supply increase and thus puts pressure on the wage to be lowered. Where is the new wage and quantity traded located?

10 Supply change The movement from S1 to S3 is a decrease in supply. At W1 the difference between S1 and S3 is the excess demand created by the decline in supply. This excess puts pressure on the price to rise. Draw in the new wage and quantity traded when the supply decreases.

11 Demand change W Q D S1 W1 Q1 Show a demand increase and explain what happens to the wage and quantity traded in the market.

12 Demand change W Q D S1 W1 Q1 Show a demand decrease and explain what happens to the wage and quantity traded in the market.

13 Typical firm behavior in perfectly competitive mkt. Marketfirm Q q W D SW D=MRP S=MRC=W Note the firm diagram is a really a small part of the market diagram, but is enlarged. W1

14 Typical firm behavior in perfectly competitive mkt. Also note on the previous slide how the supply curve of labor to this firm is a horizontal line - what is called perfectly elastic. Why is this? In this environment any one firm is so small it can not influence the wage of labor it buys. The firm wouldn’t want to offer a higher wage than W1 because being so small relative to the market it can buy all the labor it could possibly want at W1. The firm wouldn’t offer a lower wage because if it did it would soon find that it wouldn’t attract the number of workers it wanted. Workers would go to work where the wage is W1 and so the firm would have to pay W1.

15 Typical firm behavior in perfectly competitive mkt. If we ignore the firm demand for labor for a moment and focus on supply we will note wage = average labor cost = marginal resource cost. Average wage cost = (total wage cost)/(labor amount). $ Q W1 Q1 Here I picked any Q, say Q1 and note the area of the rectangle from the origin to the dashed line the total wage cost = (W1)(Q1). If you divide by Q1 you get W1.

16 Typical firm behavior in perfectly competitive mkt. The marginal resource cost = change in total labor cost change in labor amount $ Q W1 Q1 Q2 = Q2W1 - Q1W1 Q2 - Q1 = W1(Q2 - Q1) Q2 - Q1 =W1 So the MRC is the addition to cost from adding an additional unit of labor.

17 Typical firm behavior in perfectly competitive mkt. Remember the firm demand for labor is based on the MRP. Let’s digress and think about a firm selling output in a market where it is a price taker. P Q output market D S P1 P q D firm

18 Typical firm behavior in perfectly competitive mkt. The firm is a price taker in the output market and thus can sell all it wants in the output market at the going market price. The demand for the firm’s output is a horizontal line at the market price. In principle the firm is a small part of the market and merely sells at the rate set in the market. No buyer would buy at a higher price from this seller because the buyer could go elsewhere and buy at the market price. The seller wouldn’t sell for less because they can sell all they want at the market price.

19 Typical firm behavior in perfectly competitive mkt. You may recall that MR = change in total revenue change in output by one unit P Q firm output Q1 Q2 Q2’ =P1 P1 But MRP = change in TR change in labor used by one unit = P1(Q2’-Q1) The MRP is different from the MR because typically with another worker output changes by an amount different than 1 unit.

20 Typical firm behavior in perfectly competitive mkt. How much labor does a typical firm employ? The firm will hire labor up to the point where MRP = MRC. W Q labor market D S firm d=mrp S=MRC q1 W1

21 Typical firm behavior in perfectly competitive mkt. Note in the previous diagram the firm will hire labor up to level q1. This is the level of labor employed that yields the highest profit for the firm given the wage and all the other conditions in the market. (What are the other conditions?) If the firm hired one more unit of labor note it would add more to cost than to revenue and would thus lower the profit of the firm. Profit maximizers wouldn’t do this. Note the firm wouldn’t stop short of q1 for if it did it would be sacrificing units of labor that would add more revenue than cost for the firm and would thus add to profit.