1. ©McGraw-Hill Education, 2014

2. Some important questions
Why does a top professional footballer earn so much more than a professor?
Why does an unskilled worker in the EU earn more than an unskilled worker in India?
Why do market economies not manage to provide jobs for all their citizens who want to work?
Why are different methods of production used in different countries?
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3. ©McGraw-Hill Education, 2014
The demand for labour
Derived demand
the demand for a factor of production is derived from the demand for the output produced by that factor
Equilibrium wage differential
the monetary compensation for the differential non-monetary characteristics of the same job in different industries
so workers have no incentive to move between industries
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4. The demand for labour in the short run
The marginal value product of labour (MVPL) is simply the marginal product of labour in physical goods MPL multiplied by the output price.
MVPL
Employment
Wage, MVPL
Under perfect competition, with diminishing marginal productivity, the firm maximizes profit when the marginal cost of employing an extra worker equals the MVPL. W0
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5. The demand for labour in the short runW0
MVPL
Employment
Wage, MVPL
…this occurs at E
where wage = MVPL. E L*
Employment is L*.
Below L*, extra employment
adds more to revenue than
to labour costs.
Above L*, the reverse is so.
This decision is consistent
with the MR = SMC rule for
maximizing profit under
perfect competition.
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6. Demand for factors in the long run (1)
The optimum mix of capital and labour depends on the relative prices of each input.
This helps to explain why more labour-intensive means of production are used in some countries where labour is relatively abundant.
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7. Demand for factors in the long run (2)
A change in the price of one factor will have both output and substitution effects.
A rise in the wage rate leads to
substitution towards more capital-intensive techniques,
but also leads to lower total output.
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8. Monopoly &monopsony power in the labour market
A firm may have MONOPOLY power in its output market
facing a downward-sloping demand curve
so the marginal revenue product of labour (MRPL) received from expanding output is less than the MVPL as the firm must reduce price to sell more.
A firm may face MONOPSONY power in its input market
facing an upward-sloping supply curve for inputs
so the marginal cost of labour rises with employment.
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9. Monopoly & monopsony power (2)
MVPL L1
Employment
MRPL L3
Under perfect competition,
a firm sets MVPL = W0
and employs L1 workers.
Facing a downward-sloping demand curve for its product, the firm sets MRPL = W0 and employs L3 workers.
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10. Monopoly & monopsony power (3)
A monopsonist recognises
that additional employment
bids up wages for existing
workers, so MCL shows the
marginal cost of an extra
worker.
MCL
Facing a given goods
price, the monopsonist
sets MCL = MVPL and
employs L2 workers. L2 W0
MRPL
MVPL L3 L1
Employment
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11. Monopoly & monopsony power (4)
For a monopsonist who
also faces a downward-
sloping demand curve
for the product, MCL
is set equal to MRPL to
employ L4 workers. L4
MCL L2 W0
So monopoly and monopsony power both tend to reduce the firm’s demand for labour.
MRPL
MVPL L3 L1
Employment
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12. ©McGraw-Hill Education, 2014
The supply of labour
The LABOUR FORCE
all individuals in work or seeking employment.
Labour supply
for an individual, the decision on how many hours to offer to work depends on the real wage
an individual’s attitude towards leisure and income determines will influence how many hours of work are supplied at any given real wage rate.
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13. The individual’s supply curve of labour
Hours of work supplied
Real wage
SS1
For the labour supply
curve SS1, an increase
in the real wage always
Induces higher labour
supply.
SS2
Whereas for SS2,
there comes a point
where a higher wage
induces less hours of
work to be supplied:
labour supply is
backward-bending.
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14. Labour supply in aggregate
If we consider the economy as a whole, or an industry a higher real wage rate also encourages a higher participation rate.
Higher wage rates encourage those already working to supply more hours and those not working to enter the labour force.
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15. Labour market equilibrium for an industry
The industry supply curve SLSL slopes up
higher wages are needed to attract workers into the industry
For a given output demand curve, industry demand for labour slopes down
Equilibrium is W0, L0.
Quantity
of labour
Wage DL SL W0 L0
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16. A shift in product demand
Quantity
of labour
Wage DL SL W0 L0
Beginning in equilibrium,
A fall in demand for the
product also shifts the
derived demand for labour
to D'L
D'L
The new equilibrium is
at W1, L1. L1 W1
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17. A change in wages in another industry
so industry supply shifts
to the left –
S'L
Quantity
of labour
Wage DL SL W0 L0
Again starting in equilibrium,
an increase in wages in
another industry attracts
labour,
the new equilibrium is
at W2, L2. L2 W2
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18. Transfer earnings and economic rent
the minimum payments required to induce a factor of production to work in a particular job.
Economic rent
the extra payment a factor receives over and above the transfer earnings needed to induce the factor to supply its services in that use.
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19. Transfer earnings and economic rent (2)
In labour market
equilibrium at W0, L0, D
if workers were paid only
the transfer earnings, the
industry would need only
pay AEL0 in wages. SS
Wage E W0
But if all workers must be
paid the highest wage
needed to attract the
marginal worker into the
industry (W0), then workers
as a whole derive economic
rent of 0AEW0. D A L0
Quantity
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20. Concluding comments (1)
The demand for labour is derived from the demand for what it is used to produce.
Firms stop hiring workers when the value of what they produce (VMPL) begins to fall below what it costs to hire them (W).
Labour supply will fall as the wage increases if the income effect dominates the substitution effect.
A lack of competition on the buying side of the labour market (monopsony) is associated with lower employment and wages when compared to a perfectly competitive market.
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21. Concluding comments (2)
For someone already in the labour force, a rise in the hourly real wage has both a substitution effect tending to increase the supply of hours worked, and an income effect tending to reduce the supply of hours worked.
Economic rent is the difference between income received and the reservation wage for that individual.
In free market equilibrium, some workers choose not to work at the equilibrium wage rate. They are voluntarily unemployed.
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22. Concluding comments (3)
Involuntary unemployment is the difference between desired supply and desired demand at a disequilibrium wage rate.
Possible causes of involuntary unemployment are minimum wage agreements, trade unions, scale economies, insider–outsider distinctions and efficiency wages.
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