1. Chapter 29 Labor Demand and Supply

2. Slide 29-2 Introduction When the trucking industry experienced an expansion at the end of the 2001 recession, there were expectations of more employment and higher wages for truck drivers. The labor market outcome was also affected by federal regulations governing the number of hours drivers could spend on the road.

3. Slide 29-3 Learning Objectives Understand why a firm’s marginal revenue product curve is its demand for labor curve Explain in what sense the demand for labor is a “derived” demand Identify the key factors influencing the elasticity of demand for inputs

4. Slide 29-4 Learning Objectives Describe how equilibrium wage rates are determined for perfectly competitive firms Explain what labor outsourcing is and how it will affect U.S. workers’ earnings and employment prospects Contrast the demand for labor and wage determination by a product market monopolist with outcomes that would arise under perfect competition

5. Slide 29-5 Chapter Outline Marginal Physical Product Derived Demand The Market Demand for Labor Determinants of Demand Elasticity for Inputs Determinants of Demand Elasticity for Inputs

6. Slide 29-6 Chapter Outline Wage Determination Labor Outsourcing, Wages, and Employment Labor Outsourcing, Wages, and Employment

7. Slide 29-7 Chapter Outline Monopoly in the Product Market Other Factors of Production

8. Slide 29-8 Did You Know That... The principles we have used to explain the market in which goods are sold will also describe the labor market? Profit-maximizing firms will hire labor up to the point where the marginal benefit equals the marginal cost?

9. Slide 29-9 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

10. Slide 29-10 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

11. Slide 29-11 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

12. Slide 29-12 Marginal Revenue Product Total PhysicalMarginalMarginal ProductPhysical Product Revenue Product Labor Input (TPP)(MPP)(MRP) (MR = $10) 6882 71,000 81,111 91,215 101,312 111,402 121,485 131,561 Observations MPP declines MRP = MP x MR 118$1,180 111$1,110 104$1,040 97$970 90$900 83$830 76$760

13. Slide 29-13 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

14. Slide 29-14 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

15. Slide 29-15 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.

16. Slide 29-16 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.

17. Slide 29-17 International Example: Confusing MPP and MRP Violinists in the Beethoven Orchestra in Germany filed a lawsuit in 2004 asking for higher wages. Their rationale was that they play more notes than do woodwind and brass players.

18. Slide 29-18 International Example: Confusing MPP and MRP Responding to the lawsuit, orchestra managers pointed out that violinists do indeed have a higher marginal physical product (more notes) than do oboe and French horn soloists. But the marginal revenue product of the soloists is probably higher.

19. Slide 29-19 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.

20. Slide 29-20 Demand for Labor— a Derived Demand The firm produces CDs MRP 0 when price of CDs is P 0 MRP 1 when price of CDs is P 1 MRP 2 when price of CDs is P 2 MRP 0 : MRP = MFC at 12 workers MRP 1 : MRP = MFC at 10 workers MRP 2 : MRP = MFC at 15 workers Figure 29-2

21. Slide 29-21 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.

22. Slide 29-22 Derivation of the Market Demand for Labor Quantity of Labor per Time Period Wage Rate per Hour ($) Firm 0 MRP 0 = d 0 10 22 c MRP 1 = d 1 Market (200 firms) Quantity of Labor per Time Period 0 10 20 a 2000 A Wage rate of $20 firms will hire 2000 workers 15 b

23. Slide 29-23 Derivation of the Market Demand for Labor Quantity of Labor per Time Period Wage Rate per Hour ($) 10 Firm 1015220 20 MRP 1 = d 1 MRP 0 = d 0 a b Market (200 firms) Quantity of Labor per Time Period 2,0003,0000 A B D Figure 29-3

24. Slide 29-24 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

25. Slide 29-25 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.

26. Slide 29-26 The Equilibrium Wage Rate and the CD Industry Figure 29-4

27. Slide 29-27 International Example: How Long Does it Take to Earn a Big Mac? One way to make an international wage comparison is to see how long it takes the average worker in various countries to earn enough to purchase a standardized item. In the U.S., the typical worker can earn a Big Mac sandwich in 9 minutes.

28. Slide 29-28 International Example: How Long Does it Take to Earn a Big Mac? In Nigeria, the earnings necessary to purchase a Big Mac require an hour for the typical worker. This time cost for the same sandwich is 2 hours in Pakistan and 3 hours in Kenya.

29. Slide 29-29 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

30. Slide 29-30 Wage Determination Shifts in labor supply will alter the equilibrium wage rate: –Change in wages in other industries –Changes in working conditions –Job flexibility

31. Slide 29-31 International Example: Manufacturing Jobs Disappear Worldwide Though many U.S. manufacturing jobs have disappeared since 1995, it is not consistent with the data to conclude that those jobs have been relocated overseas. Manufacturing employment has declined in nearly all countries.

32. Slide 29-32 International Example: Manufacturing Jobs Disappear Worldwide The correct interpretation is that technological improvements have lessened the amount of labor input needed in industrial production. The labor resources liberated from the manufacturing process are now used in telecommunications, software design, and other endeavors.

33. Slide 29-33 Labor Outsourcing, Wages, and Employment Outsourcing: –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.

34. Slide 29-34 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.

35. Slide 29-35 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.

36. Slide 29-36 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.

37. Slide 29-37 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.

38. Slide 29-38 A Monopolist’s Marginal Revenue Product Figure 29-7, Panel (a)

39. Slide 29-39 A Monopolist’s Marginal Revenue Product Figure 29-7, Panel (b)

40. Slide 29-40 Monopoly in the Product Market What do you think? –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 her product will decline as she expands output.

41. Slide 29-41 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)

42. Slide 29-42 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.

43. Slide 29-43 Other Factors of Production Cost minimization MPP of labor price of labor = MPP of capital price of capital MPP of land price of land =

44. Slide 29-44 Issues and Applications: How A Federal Labor Rule Affected Wages A new 2003 U.S. regulation limited the number of daily hours truckers could be on the road. This had the effect of shifting the labor supply curve to the left. At the same time, the demand for trucking services was increasing due to a nationwide economic recovery.

45. Slide 29-45 Issues and Applications: How A Federal Labor Rule Affected Wages As is shown on the graph on the next slide, both the increased demand and the decreased supply for truck drivers had the effect of raising the equilibrium wage.

46. Slide 29-46 Issues and Applications: How A Federal Labor Rule Affected Wages Figure 29-8

47. Slide 29-47 Summary Discussion of Learning Objectives Why a firm’s marginal revenue product curve is its labor demand curve –In competitive markets, firms hire labor to the point at which the wage equals MRP. The demand for labor as a “derived demand” –The demand for labor by perfectly competitive firms is derived from the demand for the final products they produce.

48. Slide 29-48 Summary Discussion of Learning Objectives Key factors affecting the elasticity of demand for inputs –Price elasticity of demand for the final product –Ease of substitution of other inputs –Proportion of total costs –Time period

49. Slide 29-49 Summary Discussion of Learning Objectives How equilibrium wage rates at perfectly competitive firms are determined –The wage at which the quantity of labor supplied by all workers equals the quantity of labor demanded by all firms U. S. wage and employment effects of labor outsourcing –Decreased demand for U. S. workers when cheaper labor is available overseas –Increased demand for some U. S. labor

50. Slide 29-50 Summary Discussion of Learning Objectives Contrasting the demand for labor and wage determination under monopoly with outcomes under perfect competition –A monopolist’s labor demand curve is to the left of that of a perfectly competitive industry –Marginal revenue for a monopolist is less than price –Fewer workers are employed by the monopolist

51. End of Chapter 29 Labor Demand and Supply