Labor Market Overview
(Part 2)
The Labor Market
• Labor markets determine
– Terms of employment
• Earnings versus total compensation
• Working conditions
– Levels of employment
• These are determined by the interaction of
demand and supply
Demand for Labor
• Derived demand
– In product markets, firms produce the output level
where MR=MC
– MC depend upon prices of inputs, productivity, and
technology
– Output is produced using least cost combinations of
inputs
– So, demand for output or output price, wage rates,
prices of inputs, and technology all determine demand
for labor
Figure 2.6
Labor Demand Curve (based on data in Table 2.3)
Movements along the Labor Demand Curve
• Changes in wages:
– As wages rise or fall, the firm weighs to effects
• Scale effect – wages affect overall MC causing optimal output
and hence quantity of labor demanded to change
– W↓ → MC↓ → Q↑ → Qdl↑
– W↑ → MC↑ → Q↓ → Qdl↓
• Substitution effect – as wages change the relative cost of labor
compared to capital (or other inputs) changes
– W↓ → W/C↓ → Qdl↑ → Dk↓
– W↑ → W/C↑ → Qdl↓ → Dk↑
Shifts in the Labor Demand Curve
• Changes in demand for the product or product
price:
– As P↑ → MR↑ → Q↑ → scale effect →DL↑
– As P↓ → MR↓ → Q↓ → scale effect →DL↓
• Changes in the price of capital (or other inputs)
– As C↑ → MC↑ → scale effect → DL↓
→ W/C↓ → subst. Effect →DL↑
– As C↓ → MC↓ → scale effect → DL↑
→ W/C↑ → subst. Effect →DL↓
Therefore, the total effect of changes in C is ambiguous.
Figure 2.7
Shift in Demand for Labor Due to Increase in
Product Demand
Figure 2.8
Possible Shifts in Demand for Labor Due to Fall in
Capital Prices
Market, Industry and Firm Demand
• Market : sum all firm demand curves for labor
across all industries
• Industry : sum of firm demand curves across an
industry group
• Firm : the demand curve for a single producer
• The scale and substitution effects are likely to vary
between the firm, industry and market and in the
long-run versus the short-run. Therefore, the
responsiveness of labor demand to its
determinants will also likely vary.
Supply of Labor
• The supply of labor comes from the household/individual
decision about leisure versus goods and services
• Assuming that an individual decides to work, wages affect
the supply of labor in two ways:
– W↑(↓) → opportunity cost of leisure↑(↓)→ Subst. Effect away
from (towards) leisure towards (away from) Goods and Services or
more (less) work → Qsl↑(↓)
– W↑(↓) → income effect →purchase more leisure (less work) and
more goods and services
• Generally, we assume that the substitution effect outweighs
the income effect and supply of labor is upward sloping.
• Changes in relative wages among different
occupations could also change a person’s
occupational choice. This effect would
generally support an upward sloping supply
curve for an industry, but it would likely
have little effect on the overall market
supply of labor.
Market Supply
• Assume that the person has decided to work. The decision
is:
– What occupation?
– Which employer?
• If wage rates for a given occupation rise, ceteris paribus:
– The opportunity cost of working in other occupations will rise.
Thus, the number of people choosing the given occupation will
increase → upward sloping-supply → a movement along the
supply curve.
– If wages rates in any “related” occupation change, the supply
curve will shift.
Figure 2.9
Market Supply Curve for Secretaries
Figure 2.10
Shift in Market Supply Curve for Secretaries as Salaries of
Insurance Agents Rise
Supply to Firms
• The supply to firms depends upon whether firms
have any market power in the labor market.
– Many firms or competitive markets OR wage takers:
supply to the any one firm is perfectly elastic at the
competitive wage rate
• Firms would be foolish to offer higher wages
• Firm could not attract labor at lower wages
– One firm (monopsony) or few firms (oligopsony) OR
wage makers: the firm faces an upward sloping supply
curve of labor
• Firm hires more labor it must raise wages for new as well as
current laborers. Thus MFC (marginal factor cost) > W
• Firm hires less labor wages of all workers fall so MFC > W.
Figure 2.11
Supply of Secretaries to a Firm at Alternative Market
Wages
Market Clearing Wage
• Putting market labor demand and supply together
gives the equilibrium wage and amount of labor
hired.
• Surplus and shortage of labor and effects on the
actual wage rate.
• Comparative statics:
– Shifts in demand
•
•
•
•
Prices of other inputs
Productivity
Technology
Price of output
– Shifts in Supply
• Changes in relative wages (Egypt vs. Saudi Arabia)
• Changes in population (aging of the Japanese population)
Figure 2.12
Market Demand and Supply
Figure 2.13
Demand and Supply at the “Market”
and “Firm” Level
Figure 2.14
New Labor Market Equilibrium after Demand Shifts
Right
Figure 2.16
New Labor Market Equilibrium after Supply Shifts
Right
• Dynamic Adjustment
– Shortages and surpluses
– Labor services cannot be separated from the worker
allows for labor immobility, time lags in investing in
human capital, and efficiency wages
– Non-market influences that impede adjustment include
laws (minimum wage), customs (child labor, or
institutions (unions).
– Asymmetry between wages increases and decreases
– Unemployment, persistent disequilibrium at above
market clearing wages.
Policy Questions
• Overpaid and underpaid?
– Wages above the equilibrium level
• Wages falling would lower cost and raise output →increases in
efficiency
• More worker want jobs than can find them →unemployment
and less output for consumers at higher prices
• Bus cleaners in Houston – new cleaners paid lower wage →
Pareto-improving
– Wages below the equilibrium level
• Wages rising would increase the quantity supplied of labor and
decrease the quantity demanded of labor. More of the good
would be produced. Costs would reflect the “true” cost of
producing a product.
• Military
• Jury Duty
Figure 2.17
Effects of an Above-Equilibrium Wage
Figure 2.18
Effects of a Below-Equilibrium Wage
Figure 2.19
Labor Supply to the Military: Different Preferences
Imply Different “Rents”
• Supply curve as reservation wages and
demand curve as maximum wage
businesses are willing to pay.
– Economic rent is the amount paid to a factor of
production over and above what is necessary to
bring it to market
– In the labor market, it is the difference between
what workers are paid and their reservation
wage
International Differences in Unemployment
• Non-market forces in Europe
– High unemployment insurance (see reading)
– Increases in unemployment rate of less-educated/lowerskilled workers given the structural shifts towards hightech.
• US and Canada wages fell and unemployment rose slightly
• France and Germany wage rates rose and unemployment rose
significantly.