1. McGraw-Hill/Irwin Chapter 10: Wage Determination Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved

2. Firm’s Demand for Labor LO: 10-1  Labor is the most important of the resources used by firms.  Labor demand is a derived demand, thus it depends on  the productivity of labor  the price of the good or service it helps produce Derived demand is the demand for a resource that results from the demand for the product it helps produce 10-2

3. Marginal Revenue Product and Marginal Revenue Cost LO: 10-1  Marginal revenue product (MRP) of labor is the change in a firm’s total revenue when it employs one more unit of labor.  Marginal resource cost (MRC) of labor is the change in a firm’s total cost when it employs one more unit of labor.  In a competitive labor market, MRC is equal to market wage rate. MRP = Change in total revenue Unit change in labor MRC = Change in total cost Unit change in labor 10-3

4. MRP of Labor as Labor Demand Schedule LO: 10-1  MRP=MRC can be written as MRP=wage rate.  The MRP schedule therefore constitutes the firm’s demand for labor  because each point on this schedule (or curve) indicates the quantity of labor units the firm would hire at each possible wage rate.  The market demand for labor is the horizontal summation of all the individual firm demand curves for labor. 10-4

5. Changes in Labor Demand The labor demand curve can shift if there are:  Changes in product demand: higher product demand – higher labor demand.  Changes in productivity: higher productivity of labor – higher labor demand. Productivity depends on  Quantity of other resources  Technological advance  Quality of labor  Changes in the prices of other resources:  a decline in price of complementary resources increases labor demand  a change in price of substitute resources has an ambiguous effect on labor demand LO: 10-2 10-5

6. Elasticity of Labor Demand  Elasticity of Labor Demand (E w ) is a measure of the responsiveness of employers to a change in the wage rate.  Also called wage elasticity of demand.  E w < 1: labor demand is inelastic  E w > 1: labor demand is elastic  E w = 1: labor demand is unit-elastic E w = Percentage change in labor quantity Percentage change in the wage rate LO: 10-3 10-6

7. Changes in Elasticity of Labor Demand Wage elasticity of demand depends on:  Ease of resource substitutability: the greater the substitutability, the more elastic is the labor demand  Elasticity of product demand: the greater the elasticity of product demand, the greater the elasticity of labor demand  Ratio of labor cost to total cost: the greater the share of labor in total cost, the greater the elasticity of labor demand LO: 10-3 10-7

8. Market Supply of Labor  The supply curve for each type of labor slopes upward, indicating that firms must pay a higher wage rate in order to attract workers away from the alternative job opportunities available to them and workers not in the labor force.  The intersection of labor supply and labor demand determine the equilibrium wage rate and level of employment in a given labor market. LO: 10-4 10-8

9. Competitive Labor Market  Many employers compete for specific types of labor.  Many workers with identical skills supply that type of labor.  Individual employers are “wage takers.”  Individual firm’s labor supply is perfectly elastic at the market wage rate.  Firms use MRP=MRC rule to determine employment at market wage. LO: 10-4 10-9

10. Wage Rate (Dollars) ($10) W C ($10) W C Labor MarketIndividual Firm Quantity of Labor QCQC (1000) 00 D=MRP (∑ mrps) d=mrp qCqC (5) s=MRC S Competitive Labor Market LO: 10-4 10-10

11. Monopsony  In labor market monopsony, the single employer is a “wage maker.”  Monopsonist’s labor supply curve is the same as market labor supply curve and is upward-sloping.  The MRC curve lies above the labor supply curve and MRC exceeds the wage rate.  Monopsonist will use MRP=MRC rule to determine how much labor to hire and pay wage corresponding to this quantity supplied. LO: 10-4 Monopsony is a market structure in which there is only a single buyer of a good, service, or resource. 10-11

12. Wage Rate (Dollars) Quantity of Labor 0 S MRP MRC c b a WcWc WmWm QmQm QcQc LO: 10-4 Monopsony In monopsony, employment and wage are lower than in competitive labor market 10-12

13. Union Models  In some labor markets, workers sell their labor services collectively through labor unions.  Unions work to raise wage rates for members. LO: 10-5 Exclusive (craft) unions  Restrict supply of skilled labor to increase the wage rate received by union members Inclusive (industrial) unions  Include as members all workers in an industry  Put great pressure on firms to agree to wage demands through the threat of a strike 10-13

14. Wage Rate (Dollars) Quantity of Labor D S1S1 QcQc WcWc S2S2 WuWu QuQu Decrease In Supply Craft Union Model LO: 10-5 10-14

15. Industrial Union Model Wage Rate (Dollars) Quantity of Labor D S QcQc WcWc WuWu QuQu QeQe a b e LO: 10-5 10-15

16. Wage Differentials  Wage differentials are the differences between the wages of different groups of workers.  Wage differentials can arise either on the demand or the supply side of labor markets.  A weak labor demand will result in a low equilibrium wage, but a strong labor demand will result in a high equilibrium wage.  A low labor supply will result in a high equilibrium wage, while a higher labor supply results in a low equilibrium wage.  Members of noncompeting groups differ in their mental and physical abilities and in their levels of education and training, and therefore, they receive different compensation. LO: 10-6 10-16