Labor Markets and Earnings
Economics 230
J.F. O’Connor
The Issues
• Review the basic model of the labor market
• Equilibrium wage for a given kind of labor
is determined by intersection of supply and
demand for that kind of labor
• Why so much observed variation wage rates
and in labor earnings? We need to look at
what is behind demand and supply in the
markets for different kinds of labor.
The Firm’s Demand for Labor
• Derived from the demand for the firm’s
output.
• The firm hires labor up to the amount where
the marginal benefit of doing so equals the
marginal cost.
• For a perfectly competitive firm, the
marginal benefit of hiring another unit of
labor is the value of the marginal product.
The Value of the Marginal
Product
• The marginal product of labor MP(L) is the
change in output that arises when the
amount of labor is changed by one unit.
• The value of the marginal product of labor
VMP(L) is the price of the product, P, times
the marginal product of labor, MP(L).
VMP(L) = P*MP(L)
Labor Demand
• For a price taker, the marginal cost of a unit
of labor is the wage rate, w.
• The MB=MC condition becomes in this
case,
VMP(L) = w
The VMP(L) is the firm’s demand for labor.
• Summing across firms’ gives the market
demand for labor
Revenues per Unit of Labor
9
$
/
u
n
i
t
,
8
7
6
5
o
f
l
a
b
o
r
VMP
4
3
2
1
0
0
50
100
150
200
250
300
Person hours
350
400
450
500
Labor Supply
• The supply of labor arises from the
individual’s choice between work and
leisure. People derive utility (satisfaction)
from leisure but they also derive utility from
the goods that can be acquired with the
earned income that arises from work. The
opportunity cost of another hour of leisure
is the wage rate. As the wage rate increases,
we expect people to work more?
EquilibriumintheLaborMarket
8
7
6
$per unit
5
4
3
2
1
0
0
20
40
60
80
100
Unit
120
140
160
180
200
Shifts in Demand and Supply
• An increase in demand for labor caused by:
– An increase in demand for the product
– An increase in labor productivity
• An increase in capital per worker
• An increase in labor quality
• A technological advance
• An increase in supply caused by:
– More people join this kind of labor
– Change in labor-leisure preferences
Why do Wages Differ
•
•
•
•
•
Human capital
Ability, effort, chance
Compensating differentials
Labor Unions
Discrimination
Human Capital
• Human capital is the stock of productive
skills that a worker has as a result of
education, training, and experience.
• Workers with more human capital earn
more than workers with less. College
graduates earn 65% more than high school
graduates. Qualified electrician earns more
than an apprentice electrician. Why?
• They are more productive. Higher VMP.
Hence higher demand!
Ability, Effort, and Chance
• Major league vs. minor league players
• People who work harder tend to earn more
• Some people are lucky because they picked
a job that resulted in higher than expected
wage because of chance development.
Others picked jobs that became redundant
because of unforeseen developments.
Compensating Differentials
• Refer to differences in wages that reflect
non-monetary characteristics of the jobs
• “Good” jobs pay less than “bad” jobs
• Jobs differ in terms of a wide variety of
characteristics. For example: location, time
of day, chance of injury, colleagues,
security, prospects for advancement.
Examples
• Coal miners are better paid than other
workers with comparable skills. Why?
• Economics professors are paid less than
economists in private business. Why?
• Government employees are paid less than
persons with comparable skills in the
private sector. Why?
Signaling and Superstars
• Argument is that education is a way for people
with superior ability and motivation to convey
that information to potential employers. If
employers screen on the basis of education, the
scheme works.
• Why watch #5 play when you could be watching
#1 play? If the technology is there for people to
do so, then the demand for #1’S services will be
much higher. Common in entertainment and
professional sports
Labor Unions
• Labor unions are concerned about both
working conditions and wages.
• If there are two industries employing the
same kind of labor and one is unionized and
the other is not, then if wages in the
unionized industry are above equilibrium,
this will depress wages in the second
industry
Discrimination
• Offering different opportunities to similar
persons who differ only by race, ethnic
group, gender, age or other personal
characteristics
• How much discrimination is there at
present? Not answered by looking at
averages! Have to hold other factors
constant.
Where Do We Stand?
• Historically, there certainly was
discrimination against ethnic and racial
groups and against females in many labor
markets.
• Presently, it is more difficult to find clear
evidence of discrimination but there is a
belief that it has not disappeared entirely.