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18

EQUILIBRIUM IN THE LABOR
MARKET
•
The wage adjusts to balance the supply and demand for labor.
•
The wage equals the value of the marginal product of labor.
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Figure 4 Equilibrium in a Labor Market
Wage
(price of labor)
Supply
Equilibrium wage, W
0 Equilibrium employment , L
Demand
Quantity of
Labor
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EQUILIBRIUM IN THE LABOR
MARKET
• Labor supply and labor demand determine the equilibrium wage.
• Shifts in the supply or demand curve for labor cause the equilibrium wage to change.
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Figure 5 A Shift in Labor Supply
Wage
(price of labor)
Supply , S
S
1 . An increase in labor supply . . .
W
W
2. . . . reduces the wage . . .
0
Demand
L L Quantity of
Labor
3. . . . and raises employment .
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Shifts in Labor Supply
• An increase in the supply of labor :
• Results in a surplus of labor.
• Puts downward pressure on wages.
• Makes it profitable for firms to hire more workers.
• Results in diminishing marginal product.
• Lowers the value of the marginal product.
• Gives a new equilibrium.
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Figure 6 A Shift in Labor Demand
Wage
(price of labor)
W
W
2. . . . increases the wage . .
.
0
Supply
1. An increase in labor demand .
. .
L
D
Demand , D
L Quantity of
Labor
3. . . . and increases employment .
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Shifts in Labor Demand
• An increase in the demand for labor :
• Makes it profitable for firms to hire more workers.
• Puts upward pressure on wages.
• Raises the value of the marginal product.
• Gives a new equilibrium.
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Wage
(price of labor)
W min
Equilibrium wage, W likely to reduce employment?
Supply
0
L min
Equilibrium employment, L
How MUCH … depends on the elasticity of
Quantity of
Labor
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Who Pays for Health Insurance?
Who PAYS?!
Wage
(price of labor)
Worth $2
Supply
Why?
Equilibrium wage, W
Benefits
Costs $2
Demand
0
Wages
Equilibrium employment , L
Quantity of
Labor
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What do unions do?
Wage
(price of labor)
If workers are more skilled, they have higher MPs.
Supply
W*
Equilibrium wage , W
0 Equilibrium employment , L
Demand
Quantity of
Labor
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What do unions do?
Wage
(price of labor)
If workers are no more skilled,
Increased W
 unemployment
Supply
W*
Equilibrium wage, W
0 L* Equilibrium employment , L
What happens
To total wages,
W*L*?
A> It depends on the elasticity of demand
Demand
Quantity of
Labor
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What happens during epidemics?
Wage
(price of labor)
Labor
Suppl y
FALLS
Result:
Eq’m Output 
Eq’m wage  or

Supply
Equilibrium wage, W
BUT Labor
Demand also
FALLS
Demand
0 Equilibrium employment , L
Quantity of
Labor
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Table 2 Productivity and Wage Growth in the United States.
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What causes productivity increase?
• Physical capital

More (better) machines to work with.
• Human capital

More education.

More experience.

Better training.
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•
Physical Capital refers to the equipment and structures used to produce goods and services.
• The economy’s capital represents the accumulation of goods produced in the past that are being used in the present to produce new goods and services.
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• Prices of Land and Capital
• The purchase price is what a person pays to own a factor of production indefinitely.
• The rental price is what a person pays to use a factor of production for a limited period of time.
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Equilibrium in the Markets for Land and
Capital
• The rental price of land and the rental price of capital are determined by supply and demand.
• The firm increases the quantity hired until the value of the factor’s marginal product equals the factor’s price.
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Figure 7 The Markets for Land and Capital
Rental
Price of
Land
P
0
(a) The Market for Land
Supply
Q
Demand
Quantity of
Land
Rental
Price of
Capital
P
(b) The Market for Capital
Supply
0 Q
Demand
Quantity of
Capital
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Equilibrium in the Markets for Land and
Capital
• Each factor’s rental price must equal the value of its marginal product.
• They each earn the value of their marginal contribution to the production process.
P x MPP labor
= wage
P x MPP capital
= capital rent
P x MPP land
= land rent
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P x MPP labor
P x MPP capital
= wage
= capital rent for example,
P = capital rent/MPP capital capital rent/MPP capital x MPP labor
= wage
MPP labor
/MPP capital
= wage / capital rent
Ratio of Mgl Products = Ratio of factor prices
So if daily wage is $100, and daily rental is $500, what can we say about ratio of Mgl Products?
A> MPP labor
/MPP capital
= 100/500
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MPP labor
/MPP capital
= wage / capital rent
Ratio of Mgl Products = Ratio of factor prices
MPP labor
/ wage = MPP capital
/ capital rent
Bang/$ = Bang/$
If Bang/$ for laborers is GREATER than for machines, what do we do? Why?
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Linkages among the Factors of Production
• Factors of production are used together.
• The marginal product of any one factor depends on the quantities of all factors that are available.
• A change in the supply of one factor alters the earnings of all the factors.
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Linkages among the Factors of Production
• A change in earnings of any factor can be found by analyzing the impact of the event on the value of the marginal product of that factor.
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Summary
• The economy’s income is distributed in the markets for the factors of production.
• The three most important factors of production are labor, land, and capital.
• The demand for a factor, such as labor, is a derived demand that comes from firms that use the factors to produce goods and services.
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Summary
• Competitive, profit-maximizing firms hire each factor up to the point at which the value of the marginal product of the factor equals its price.
• The supply of labor arises from individuals’ tradeoff between work and leisure.
• An upward-sloping labor supply curve means that people respond to an increase in the wage by enjoying less leisure and working more hours.
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Summary
• The price paid to each factor adjusts to balance the supply and demand for that factor.
• Because factor demand reflects the value of the marginal product of that factor, in equilibrium each factor is compensated according to its marginal contribution to the production of goods and services.
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Summary
• Because factors of production are used together, the marginal product of any one factor depends on the quantities of all factors that are available.
• As a result, a change in the supply of one factor alters the equilibrium earnings of all the factors.
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