13e
Chapter 30:
The Labor Market
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
The Labor Market
• There isn’t just one labor market because
everyone is not qualified to do every job.
• Some jobs pay more, some jobs pay less.
• As with any market, the various labor
markets are governed by the supply of labor
and the demand for labor. And the market
will determine the price of labor – that is,
the wage.
30-2
Learning Objectives
• 30-01. Know what factors shape labor
supply and demand.
• 30-02. Know how market wage rates are
established.
• 30-03. Know how wage floors alter labor
market outcomes.
30-3
Labor Supply
• Labor supply: the willingness and ability to
work specific amounts of time at alternative
wage rates in a given time period.
– As with any supply of anything, people, in
general, will be willing to work more hours if
the pay is higher and fewer hours if the pay is
lower, ceteris paribus.
– In addition to being paid for work, there is also
an intrinsic satisfaction one gets from working.
30-4
Labor Supply
• There is value in not working, too. It is
called enjoying leisure time.
– Economists divide your time into work hours
and leisure hours. The two together add up to
24 hours a day.
– The opportunity cost of working more hours is
the value you place on the leisure hours you
give up to work those extra hours.
30-5
Labor Supply
• If you have 24 hours of leisure, taking a job
requires you to give up some of those hours.
– The opportunity cost of doing so is very low.
• As you increase work hours, you must give up
leisure hours that are more valuable to you.
– As work hours increase, the opportunity cost rises
rapidly as leisure hours become more scarce.
– You will require a higher wage to compensate for
this increasing opportunity cost. This is the basis
for overtime pay.
30-6
Labor Supply
• Therefore, we will supply more labor hours
only if offered a higher wage.
– The labor supply curve slopes upward.
• From a marginal utility (MU) point of view, the
first few dollars you earn have a very high MU,
but as you work more hours and earn more
money, the MU of income may decline.
– This reinforces the need for a higher wage to get us
to work more hours.
30-7
Labor Supply
• At some wage, even more wages may not
induce us to work more hours.
• In fact, increased wages may induce us to work
fewer hours, not more:
– Say, each week you earn $10 an hour working 60
hours, or a total of $600. This amount is enough to
fund your lifestyle.
– Now you are offered a raise to $15 an hour. It is
possible you would cut back to 40 hours and earn
$600. You increase your leisure time by 20 hours.
30-8
Labor Supply
• There are two effects in operation here:
– Substitution effect of higher wages: an increased
wage rate encourages people to work more hours
(substitute labor for leisure).
– Income effect of higher wages: an increased wage
rate allows a person to reduce hours worked
without losing income.
• At low wages, the substitution effect
dominates; at high incomes, the income effect
dominates.
30-9
Labor Supply
• The resulting labor
supply curve bends
backward.
• The wage rate where
the income effect
begins to dominate is
where the curve
begins to bend
backward.
30-10
Market Supply
• The market supply of labor is the collective
individual labor supply.
• The market supply curve will shift if any
determinant changes:
– Tastes (for leisure, income, and work).
– Income and wealth.
– Expectations (of a change in income or
consumption requirement).
– Prices (of consumer goods).
– Taxes.
30-11
Elasticity of Labor Supply
• Consider day laborers or any low-skill job.
– How many people are currently qualified to do
the work?
– Of those, how many are currently available to be
hired?
– How long is the “pipeline” – that is, the time
required to become qualified to do the job?
30-12
Elasticity of Labor Supply
• For low-skill jobs, the supply of labor is
large and the time to qualify is short.
• A very small % increase in the wage rate
would generate a large % increase in
applicants.
– For low-skill jobs, labor supply is highly elastic.
30-13
Elasticity of Labor Supply
• Consider surgery nurses or any high-skill
job.
– How many people are currently qualified to do
the job?
– Of those, how many are currently available to be
hired?
– How long is the “pipeline” – that is, the time
required to become qualified to do the job?
30-14
Elasticity of Labor Supply
• For high-skill jobs, the supply of labor is
small and the time to qualify is long.
• A large % increase in the wage rate would
generate a small % increase in applicants.
– For high-skill jobs, labor supply is highly
inelastic.
30-15
Labor Demand
• Labor demand: the quantities of labor
employers are willing and able to hire at
alternative wage rates in a given time period.
– Labor demand is not independent. Firms don’t hire
just to have people around.
– Labor demand is a derived demand – that is, it is
derived from the demand for the goods and
services being made.
• Firms will be willing to hire more workers at
low wage rates and fewer workers as wage
rates rise.
30-16
Labor Demand
• Labor is a factor input to the process used to
generate a salable product.
• The value to the firm of an added worker is
related to the added sales revenue –
marginal revenue (MR) – received when the
added output is sold.
• The added output a new hire can produce is
called marginal physical product (MPP).
30-17
Labor Demand
Change in total revenue
Marginal revenue (MR) =
Change in output
Change in output
Marginal physical product (MPP) =
Change in quantity of labor
• Put these two ratios together to get the dollar
value of a worker’s contribution to the firm’s
output: marginal revenue product (MRP).
30-18
Labor Demand
• Assume the firm can sell all its output at the
market price, so MR = p.
• The value of a worker, MRP, is equal to the
product of price (p) and marginal physical
product (MPP).
Change in total revenue
Marginal revenue product =
Change in quantity of labor
MRP =
MPP X p
30-19
Labor Demand
• Marginal revenue product (MRP) sets the
upper limit to the wage an employer will pay.
• MRP is subject to the law of diminishing
returns.
– As more workers are hired, MPP begins to diminish
because capital is fixed in the short run.
• As MPP diminishes, so does MRP.
– Recall that MRP = MPP X p
• MRP is the firm’s demand curve and slopes
downward.
30-20
The Hiring Decision
• Compare benefit to cost.
• The benefit is MRP; the
cost is the wage rate.
• If MRP > wage (point B),
add workers and profit
rises.
• If MRP < wage (point D),
lay off workers and profit
rises.
• The ideal number of
workers exists where
MRP = wage (point C),
where profit is
maximized.
30-21
Changing Wages
• Lower the wage rate
and the firm will hire
more workers, and
vice versa.
– If the wage falls from
$4 to $2, one more
worker will be hired
(point D).
– If the wage rises from
$4 to $6, one worker
will be laid off (point
G).
30-22
Changing Productivity
• Start at point C.
• Increase
productivity and
MRP shifts right
(and vice versa).
• The firm could hire
one more worker
(point E) or increase
wages (point F).
30-23
Labor Market Equilibrium
• The intersection of labor market demand
and labor market supply sets the
equilibrium wage.
• At this rate, the quantity of labor supplied
equals the quantity of labor demanded.
– Above this rate, there is a surplus of labor.
– Below this rate, there is a shortage of labor.
30-24
Minimum Wage
• A governmentimposed minimum
wage is set at WM,
above the market
wage of We.
• A surplus is created.
• Some workers (0 to
qd) benefit with
higher pay; some lose
their jobs (qd to qe);
some start looking
but can’t find jobs (qe
to qs).
30-25
Minimum Wage
• A minimum wage
– Reduces the quantity of labor demanded.
– Increases the quantity of labor supplied.
– Creates a market surplus.
• A minimum wage increase makes all three
results worse.
• The minimum wage applies mainly to the lowskill end of the labor market, so supply is
highly elastic. Firms cut jobs at a greater rate
than the minimum wage increase.
30-26
Choosing among Inputs
• When deciding whether to hire more labor
or to add more capital, a firm will compare
the cost efficiency of each.
– Cost efficiency: the amount of output associated
with an additional dollar spent on an input; the
MPP of an input divided by its price (or cost).
– The most cost-efficient input is the one that
produces the most added output per dollar.
30-27
Choosing among Inputs
• Compare MPP/P for labor to MPP/P for
capital.
– If labor is more cost-efficient, add workers and
the process becomes more labor-intensive.
• In countries where labor is cheap and capital is
expensive, work is labor-intensive.
– If capital is more efficient, add capital and the
process becomes more capital-intensive.
• In countries where labor is expensive and capital is
cheap, work is capital-intensive.
30-28