Copyright©2004 South-Western 18 Labor Market Equilibrium

Copyright © 2004 South-Western EQUILIBRIUM IN THE LABOR MARKET The wage adjusts to balance the supply and demand for labor. The wage equals the value of the marginal product of labor.

Figure 4 Equilibrium in a Labor Market Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply Demand Equilibrium wage,W Equilibrium employment,L

Copyright © 2004 South-Western EQUILIBRIUM IN THE LABOR MARKET Labor supply and labor demand determine the equilibrium wage. Shifts in the supply or demand curve for labor cause the equilibrium wage to change.

Figure 5 A Shift in Labor Supply Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply,S Demand reduces the wage and raises employment. 1. An increase in labor supply... S W L W L

Copyright © 2004 South-Western Shifts in Labor Supply An increase in the supply of labor : Results in a surplus of labor. Puts downward pressure on wages. Makes it profitable for firms to hire more workers. Results in diminishing marginal product. Lowers the value of the marginal product. Gives a new equilibrium.

Figure 6 A Shift in Labor Demand Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply Demand,D increases the wage and increases employment. D W L W L 1. An increase in labor demand...

Copyright © 2004 South-Western Shifts in Labor Demand An increase in the demand for labor : Makes it profitable for firms to hire more workers. Puts upward pressure on wages. Raises the value of the marginal product. Gives a new equilibrium.

What is the Effect of a Minimum Wage? Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply Demand Equilibrium wage,W Equilibrium employment,L W min L min Why is minimum wage likely to reduce employment? How MUCH … depends on the elasticity of demand for labor. Why?

Who Pays for Health Insurance? Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply Demand Equilibrium wage,W Equilibrium employment,L Costs $2 Worth $2 Wages Benefits Who PAYS?! Why?

What do unions do? Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply Demand Equilibrium wage,W Equilibrium employment,L If workers are more skilled, they have higher MPs. W*

What do unions do? Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply Demand Equilibrium wage,W Equilibrium employment,L If workers are no more skilled, Increased W  unemployment W* What happens To total wages, W*L*? A> It depends on the elasticity of demand L*

What happens during epidemics? Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply Demand Equilibrium wage,W Equilibrium employment,L Labor Suppl y FALLS BUT Labor Demand also FALLS Result: Eq’m Output  Eq’m wage  or  Result: Eq’m Output  Eq’m wage  or 

Table 2 Productivity and Wage Growth in the United States. Copyright©2004 South-Western

What causes productivity increase? Physical capital  More (better) machines to work with. Human capital  More education.  More experience.  Better training.

Copyright © 2004 South-Western OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL Physical Capital refers to the equipment and structures used to produce goods and services. The economy’s capital represents the accumulation of goods produced in the past that are being used in the present to produce new goods and services.

Copyright © 2004 South-Western OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL Prices of Land and Capital The purchase price is what a person pays to own a factor of production indefinitely. The rental price is what a person pays to use a factor of production for a limited period of time.

Copyright © 2004 South-Western Equilibrium in the Markets for Land and Capital The rental price of land and the rental price of capital are determined by supply and demand. The firm increases the quantity hired until the value of the factor’s marginal product equals the factor’s price.

Figure 7 The Markets for Land and Capital Copyright©2003 Southwestern/Thomson Learning Quantity of Land 0 Rental Price of Land Demand Supply Demand Supply Quantity of Capital 0 Rental Price of Capital Q P (a) The Market for Land(b) The Market for Capital P Q

Copyright © 2004 South-Western Equilibrium in the Markets for Land and Capital Each factor’s rental price must equal the value of its marginal product. They each earn the value of their marginal contribution to the production process. P x MPP labor = wage P x MPP capital = capital rent P x MPP land = land rent

Copyright © 2004 South-Western Equilibrium in the Markets for Land and Capital P x MPP labor = wage P x MPP capital = capital rent P = capital rent/MPP capital capital rent/MPP capital x MPP labor = wage MPP labor /MPP capital = wage /capital rent Ratio of Mgl Products = Ratio of factor prices So if daily wage is $100, and daily rental is $500, what can we say about ratio of Mgl Products? A> MPP labor /MPP capital = 100/500 for example,

Copyright © 2004 South-Western Equilibrium in the Markets for Land and Capital MPP labor /MPP capital = wage /capital rent Ratio of Mgl Products = Ratio of factor prices MPP labor / wage = MPP capital /capital rent Bang/$ = Bang/$ If Bang/$ for laborers is GREATER than for machines, what do we do? Why?

Copyright © 2004 South-Western Linkages among the Factors of Production Factors of production are used together. The marginal product of any one factor depends on the quantities of all factors that are available. A change in the supply of one factor alters the earnings of all the factors.

Copyright © 2004 South-Western Linkages among the Factors of Production A change in earnings of any factor can be found by analyzing the impact of the event on the value of the marginal product of that factor.

Copyright © 2004 South-Western Summary The economy’s income is distributed in the markets for the factors of production. The three most important factors of production are labor, land, and capital. The demand for a factor, such as labor, is a derived demand that comes from firms that use the factors to produce goods and services.

Copyright © 2004 South-Western Summary Competitive, profit-maximizing firms hire each factor up to the point at which the value of the marginal product of the factor equals its price. The supply of labor arises from individuals’ tradeoff between work and leisure. An upward-sloping labor supply curve means that people respond to an increase in the wage by enjoying less leisure and working more hours.

Copyright © 2004 South-Western Summary The price paid to each factor adjusts to balance the supply and demand for that factor. Because factor demand reflects the value of the marginal product of that factor, in equilibrium each factor is compensated according to its marginal contribution to the production of goods and services.

Copyright © 2004 South-Western Summary Because factors of production are used together, the marginal product of any one factor depends on the quantities of all factors that are available. As a result, a change in the supply of one factor alters the equilibrium earnings of all the factors.