Chapter 29: Labor Demand and Supply ECON 152 – PRINCIPLES OF MICROECONOMICS Chapter 29: Labor Demand and Supply Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

The principles we have used to explain the output markets in which goods are sold will also describe the labor and other input markets where inputs are bought. Profit-maximizing firms will hire labor up to the point where the marginal benefit (MRP) equals the marginal cost (MFC).

Competition in the Product Market Assumptions Each employer is one of a very large number of employers Workers do not need special skills Workers are free to move from one employer to another The firm is a price taker

Marginal Physical Product Marginal Physical Product (MPP) of Labor The change in output resulting from the addition of one more worker The change in total output accounted for by hiring the worker, holding all other factors of production constant MPP eventually declines because of the law of diminishing returns

Marginal Physical Product Marginal Revenue Product (MRP) The marginal physical product (MPP) times the marginal revenue The additional revenue obtained from a one-unit change in labor input

Marginal Revenue Product Total Physical Marginal Marginal Product Physical Product Revenue Product Labor Input (TPP) (MPP) (MRP) (MR = $10) 6 882 7 1,000 8 1,111 9 1,215 10 1,312 11 1,402 12 1,485 13 1,561 118 $1,180 111 $1,110 104 $1,040 97 $970 90 $900 83 $830 76 $760 Observations • MPP declines • MRP = MP x MR

Marginal Physical Product Marginal Factor Cost (MFC) The cost of using an additional unit of an input Marginal factor cost = change in total cost change in amount of resources used

Marginal Physical Product In a perfectly competitive labor market: The market determines the wage The individual employer is a wage taker All workers are hired for the same wage MFC = wage

Marginal Revenue Product The MRP curve: demand for labor The MRP curve is the demand curve for labor for the firm. This tells us how many workers will be hired at various possible wage rates. The firm will hire any worker who can contribute to revenues by more than they contribute to costs.

Marginal Physical Product General rule for hiring The firm hires workers up to the point at which the additional cost associated with hiring the last worker is equal to the additional revenue generated by that worker. MRP = MFC

Derived Demand Derived Demand The factors of production are needed to manufacture a final good or to provide a final service. Thus, the demand for labor is influenced by demand for the final product.

Demand for Labor— a Derived Demand The firm produces CDs • MRP0 when price of CDs is P0 • MRP1 when price of CDs is P1 • MRP2 when price of CDs is P2 • MRP0: MRP = MFC at 12 workers • MRP1: MRP = MFC at 10 workers • MRP2: MRP = MFC at 15 workers P1 reflects the effect of a lower product price. P2 reflects the effect of a higher product price. Figure 29-2

The Market Demand for Labor The quantity of labor demanded for a particular type of labor in each industry will vary as the wage rate changes. The market demand for labor will generally be less elastic than the demand exhibited by one firm.

Derivation of the Market Demand for Labor with Drop in Wage Rate Firm Market (200 firms) a A 20 Increased supply leads to reduced market price, so MRP shifts inward. Wage Rate per Hour ($) b B 10 MRP0 = d0 D MRP1 = d1 10 15 22 2,000 3,000 Quantity of Labor per Time Period Quantity of Labor per Time Period Figure 29-3

Determinants of Demand Elasticity for Inputs The price elasticity of demand for a variable input will be greater The greater the price elasticity of demand for the final product The easier it is for a particular variable input to be substituted for by other inputs The larger the proportion of total costs accounted for by a particular variable input The longer the time period being considered

Wage Determination The demand for labor curve has been determined. Now add an analysis of labor supply. We can derive the equilibrium wage rate that workers earn in an industry.

The Equilibrium Wage Rate and the CD Industry Figure 29-4

Wage Determination Shifts in the market demand for labor will alter the equilibrium wage rate: Change in demand for the final product Change in labor productivity Change in the price of related inputs

Wage Determination Shifts in labor supply will alter the equilibrium wage rate: Change in wages in other industries Changes in working conditions Job flexibility

Labor Outsourcing, Wages, and Employment A firm’s employment of labor outside the country in which the firm is located. Some U.S.-based companies outsource labor to other countries. Some firms based around the globe outsource labor to the U.S.

Labor Outsourcing, Wages, and Employment How are U.S. workers affected? If cheaper labor is available in other countries, this will dampen the demand for U.S. labor. But as the volume of global commerce rises, there may be more of a demand by foreign firms to hire U.S. workers as well. Instructor Note: Observe the timing of the chain of events.

Labor Outsourcing, Wages, and Employment The long-term effects: Labor outsourcing enhances trade, which allows for more specialization. If goods are produced and services are performed in those countries where the opportunity costs are lowest, then global economic growth is enhanced.

Labor Outsourcing, Wages, and Employment Benefits for U.S. workers: To the extent that firms can outsource their labor needs, they will operate more efficiently. This means that the products they sell have lower prices. In turn, each dollar in a worker’s paycheck has a greater purchasing power.

Monopoly in the Product Market Constructing the monopolist’s input demand curve In reconstructing the demand schedule for an input, we must recognize that: The marginal physical products falls because of the law of diminishing returns as more workers are added. The price (and marginal revenue) received for the product sold also falls as more is produced and sold.

A Monopolist’s Marginal Revenue Product Figure 29-7, Panel (a)

A Monopolist’s Marginal Revenue Product Figure 29-7, Panel (b)

Monopoly in the Product Market Why does the monopolist hire fewer workers? The marginal benefit to the monopolist of hiring an additional worker is affected by the fact that the selling price of the product will decline as output is expanded.

Other Factors of Production Profit maximization revisited MRP of labor = price of labor (wage) MRP of land = price of land (rent) MRP of capital = price of capital (cost per unit of service)

Other Factors of Production Cost minimization To minimize total costs for a particular rate of production, the firm will hire factors of production up to the point at which the marginal physical product per last dollar spent on each factor is equalized.

Other Factors of Production Cost minimization MPP of labor price of labor = MPP of capital price of capital MPP of land price of land

Chapter 29: Labor Demand and Supply ECON 152 – PRINCIPLES OF MICROECONOMICS Chapter 29: Labor Demand and Supply Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.