Wage Determination
CHAPTER TEN
WAGE DETERMINATION
ANSWERS TO END-OF-CHAPTER QUESTIONS
10-1
Explain the meaning and significance of the fact that the demand for labor is a derived demand.
Why do labor demand curves slope downward?
Consumers don’t demand labor directly, they demand the goods that labor produces. Consumers
demand goods and services from businesses, who in turn demand the labor resources. If the
demand for a product falls, the demand for labor to produce that product will also fall.
The labor demand curve is the marginal revenue product (MRP) curve facing the firm. MRP is
determined by marginal product (MP) and product price. Even in a competitive market where
product price is constant, MRP (and thus labor demand) will slope downward because of
diminishing returns – each additional unit of labor will add less to total output and therefore less
to total revenue.
10-2
Complete the following labor demand table for a firm that is hiring labor competitively and
selling its product in a purely competitive market.
Units
of
labor
Total
product
Marginal
product
Product
price
Total
revenue
0
1
2
3
4
5
6
0
17
31
43
53
60
65
____
____
____
____
____
____
____
$2
2
2
2
2
2
2
$____
____
____
____
____
____
____
Marginal
revenue
product
$____
____
____
____
____
____
a. How many workers will the firm hire if the going wage rate is $11.95? $19.95? Explain
why the firm will not hire a larger or smaller number of units of labor at each of these wage
rates.
b. Show in schedule form and graphically the labor demand curve of this firm.
Marginal product data, top to bottom: 17; 14; 12; 10; 7; 5. Total revenue data, top to bottom:
$0, $34; $62; $86; $106; $120; $130. Marginal revenue product data, top to bottom: $34; $28;
$24; $20; $14; $10.
(a) Five workers at $11.95 because the MRP of the first five workers exceeds $11.95. The MRP
of the sixth worker is less than $11.95 ($10), so he or she will not be hired.
(b) The demand schedule consists of the first and last columns of the table:
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Wage Determination
10-2b
10-3
Suppose that marginal product tripled while product price fell by one-half in the table in Figure
10.1. What would be the new MRP values in the table? What would be the net impact on the
location of the resource demand curve in Figure 10.1?
New MRP values (top to bottom): $21, 18, 15, 12, 9, 6, 3.
The resource demand curve would shift up, with the MRP fifty percent greater for each quantity
of resource demanded.
10-4
In 2002 Boeing reduced employment by 33,000 workers due to reduced demand for aircraft.
What does this decision reveal about how it viewed its marginal revenue product (MRP) and
marginal resource cost (MRC)? Why didn’t Boeing reduce employment by more than 33,000
workers? By less than 33,000 workers?
Boeing’s decision suggests that the MRC of those 33,000 workers was greater than the MRP.
Boeing didn’t reduce employment further because the MRP of the remaining workers exceeds
the MRC. Reducing employment by less than 33,000 workers would have left Boeing with some
employees for whom the MRC exceeded the MRP, reducing the company’s profits.
10-5
How will each of the following affect the demand for resource A, which is being used to produce
commodity Z?
a. An increase in the demand for product Z.
b. An increase in the price of substitute resource B.
c. A technological improvement in the capital equipment with which resource A is combined.
d. A fall in the price of complementary resource C.
e. A decline in the elasticity of demand for product Z due to a decline in the competitiveness of
the product market.
Increase in the demand for resource A: (a), (c), (d). Decrease in the demand for A: (e) – lower
output with imperfect competition implies less resource demand. Uncertainty: (b) – depends on
whether the output or substitution effect is larger.
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Wage Determination
10-6
What effect would each of the following have on elasticity of demand for resource A, which is
being used to produce commodity Z?
a. An increase in the number of resources substitutable for A in producing Z.
b. Due to technological change, much less of resource A is used relative to resources B and C in
the production process.
c. The elasticity of demand for product Z greatly increases.
The demand for resource A will become more elastic with (a) and (c), and become more inelastic
with (b).
10-7
Florida citrus growers say that the recent crackdown on illegal immigration is increasing the
market wage rates necessary to get their oranges picked. Some are turning to $100,000 to
$300,000 mechanical harvesters known as “trunk, shake, and catch” pickers, which vigorously
shake oranges from trees. If widely adopted, how will this substitution affect the demand for
human orange pickers? What does that imply about the relative strengths of the substitution and
output effects?
The effect of the adoption of the mechanical pickers will be to decrease the demand for human
pickers. If this occurs, the substitution effect will have been greater than the output effect.
10-8
Why is a firm in a purely competitive labor market a wage taker? What would happen if it
decided to pay less than the going market wage rate?
A firm in a purely competitive labor market is a wage taker because there are a large number of
firms wanting to buy the labor services of the workers in that market and a large number of
workers with identical skills wanting to sell their labor services. As a result, the individual firm
has no control over the price of labor.
If a firm attempted to pay a wage below the going wage, no workers would offer their services to
that firm.
10-9
Complete the following labor supply table for a firm hiring labor competitively.
Units
of labor
Wage
Rate
Total
labor cost
(wage bill)
Marginal
resource
(labor) cost
0
1
2
3
4
5
6
$14
14
14
14
14
14
14
$____
____
____
____
____
____
____
$____
____
____
____
____
____
a. Show graphically the labor supply and marginal resource (labor) cost curves for this firm.
Explain the relationships of these curves to one another.
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Wage Determination
b. Plot the labor demand data of question 2 on the graph in part a above. What are the
equilibrium wage rate and level of employment? Explain.
Total labor cost data, top to bottom: $0; $14; $28; $42; $56; $70; $84. Marginal resource cost
data: $14, throughout.
(a) The labor supply curve and MRC curve coincide as a single horizontal line at the market
wage rate of $14. The firm can employ as much labor as it wants, each unit costing $14;
wage rate = MRC because the wage rate is constant to the firm.
(b) Graph: equilibrium is at the intersection of the MRP and MRC curves. Equilibrium wage
rate = $14; equilibrium level of employment = 5 units of labor. Explanation: From the
tables: MRP exceeds MRC for each of the first four units of labor, MR = MC for the fifth
unit, but MRP is less than MRC for the fifth unit.
10-9b
10-10 Assume a firm is a monopsonist that can hire its first worker for $6 but must increase the wage
rate by $3 to attract each successive worker. Draw the firm’s labor supply and marginal resource
cost curves and explain their relationships to one another. On the same graph, plot the labor
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Wage Determination
demand data of question. What are the equilibrium wage rate and level of employment? What
will be the equilibrium wage rate and the level of employment? Why do these differ from your
answer to question 9?
The monopsonist faces the market labor supply curve S—it is the only firm hiring this labor.
MRC lies above S and rises more rapidly than S because all workers get the higher wage rate that
is needed to attract each added worker. Equilibrium wage/rate = $12; equilibrium employment =
3 (where MRP = MRC). The monopsonist can pay a below-competitive wage rate by restricting
its employment.
10-10
10-11 Contrast the methods used by inclusive unions and exclusive unions to raise union wage rates.
Inclusive unions, also known as industrial unions, try to organize all workers so as to gain
monopoly power in the selling of labor. A successful inclusive union would be able to secure a
wage rate for its members higher than the equilibrium wage (and similar to a minimum wage –
see Figure 10.5).
Exclusive (or craft) unions attempt to restrict membership and reduce the supply of labor.
Successfully restricting labor supply will result in higher wages for union members (see Figure
10.4). Exclusive unions restrict supply by limiting (through numbers, fees, or credentials) the
number of workers available for hire in a particular profession. They also tend to support
immigration restrictions, reduced child labor, mandatory retirements, and a shorter workweek.
10-12 What is meant by investment in human capital and compensating wage differentials? Use these
concepts to explain wage differentials.
Investment in human capital is any action that improves a worker’s skills and abilities, i.e.,
increases the productivity of workers. Workers with more human capital will have higher MRPs,
meaning the demand for these workers will also be greater than for those with less human capital.
Greater demand will, ceteris paribus, result in higher wages for more skilled (and productive)
workers.
Compensating wage differentials refer to the variety of nonmonetary factors that explain why
otherwise identical workers would be willing to accept different wages. Jobs that are more
unpleasant (trash collection) or dangerous (high-rise construction worker) will tend to pay a
higher wage than jobs that are more enjoyable and/or less risky. Similarly working all day in the
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Wage Determination
hot sun or working the graveyard shift will tend to draw a higher wage than working in an air
conditioned facility during a regular 9 to 5 workday.
10-13 Why might an increase in the minimum wage in the United States simply send some jobs abroad?
Relate your answer to elasticity of labor demand.
An increase in the minimum wage will decrease the quantity hired in the domestic labor market;
how much quantity falls depends on the elasticity of labor demand. If labor demand is relatively
elastic, this may be because firms can easily substitute foreign labor for domestic workers.
Under these circumstances, an increase in the minimum wage would send jobs abroad.
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