Chapter 28Chapter 28

Labor Demand and Labor Demand and SupplySupply

(How many laborers should a firm (How many laborers should a firm hire, and at what wage?)hire, and at what wage?)

The Factor Market – Perfect The Factor Market – Perfect CompetitionCompetition

• In the factor market households supply In the factor market households supply their labor, capital and natural resources their labor, capital and natural resources in markets that are perfectly competitive, in markets that are perfectly competitive, or 1 of the imperfect forms of competition.or 1 of the imperfect forms of competition.

• Perfect Competition:Perfect Competition:– Supply of labor is perfectly elasticSupply of labor is perfectly elastic– At equilibrium wage rate the firm can hire as At equilibrium wage rate the firm can hire as

many laborer as it wants tomany laborer as it wants to

Marginal Physical ProductMarginal Physical Product• (MPP)(MPP) - - ∆ in output that results from the ∆ in output that results from the

addition of 1 more workeraddition of 1 more worker– Declines due to diminishing marginal returnsDeclines due to diminishing marginal returns

• Marginal Revenue Product: Marginal Revenue Product: the the incremental worker’s contribution to the incremental worker’s contribution to the firm’s total revenuefirm’s total revenue

• Marginal Factor Cost:Marginal Factor Cost: the wage rate of the wage rate of each workereach worker

• = = ∆ in TC∆ in TC (See pg. 677)(See pg. 677) ∆ ∆ in amount of resource usedin amount of resource used

- Wage rate = $830 In a PC market this is also the - Wage rate = $830 In a PC market this is also the perfectly elastic supply curve - firm can purchase all perfectly elastic supply curve - firm can purchase all the labor it wants at this wage (Panel b)the labor it wants at this wage (Panel b)

Hiring RuleHiring Rule• Hire to the point where add.’l cost of Hire to the point where add.’l cost of

hiring 1 more worker = add.’l hiring 1 more worker = add.’l revenue generated by that workerrevenue generated by that worker

– For perfect competition this is = to wage rate For perfect competition this is = to wage rate = MRP= MRP

– Panel b p. 677 - Panel b p. 677 - s drawn @ wage rates drawn @ wage rated curve is the MRPd curve is the MRP

E is where the 2 E is where the 2 intersect (MFC = MRP)intersect (MFC = MRP)

Derived DemandDerived Demand

• Labor demanded b/c it is used to Labor demanded b/c it is used to produce output that will be sold for a produce output that will be sold for a profitprofit

• If the price of the product produced rises or If the price of the product produced rises or falls, the MRP will shift accordingly, & fewer falls, the MRP will shift accordingly, & fewer or more workers will be neededor more workers will be needed

Market Demand for LaborMarket Demand for Labor(28-3 p. 681)(28-3 p. 681)

• $20 - 10 people - market supply of 2000$20 - 10 people - market supply of 2000

• Wage decrease to $10 means more hired Wage decrease to $10 means more hired up to 15up to 15

• As firms hire more, supply increases & As firms hire more, supply increases & price of the product will fallprice of the product will fall

• (Panel a) MRP curve shifts L to d1 & each (Panel a) MRP curve shifts L to d1 & each firm’s labor increases to 15 - market Q is firm’s labor increases to 15 - market Q is 30003000

Determinants of Demand Determinants of Demand Elasticity for InputsElasticity for Inputs• % % ∆ in Qd / % ∆ in price of labor∆ in Qd / % ∆ in price of labor

– Less than 1 = inelasticLess than 1 = inelastic– = 1 = unit-elastic= 1 = unit-elastic– More than 1 = elasticMore than 1 = elastic

• Determinants – greater if:Determinants – greater if:– Pe for final product is greaterPe for final product is greater– Input is easily substitutedInput is easily substituted– Larger proportion of total costs accounted for Larger proportion of total costs accounted for

by a particular variable inputby a particular variable input– Longer time period being consideredLonger time period being considered

Wage DeterminationWage Determination• Supply curve for labor sloped up for Supply curve for labor sloped up for industryindustry

– Individual firm can hire all they want @ Individual firm can hire all they want @ going rates, (b/c the firm represents such a going rates, (b/c the firm represents such a small part of the market) – so the firm’s small part of the market) – so the firm’s supply curve for labor is perfectly elasticsupply curve for labor is perfectly elastic

– If industry wage rate goes up or down If industry wage rate goes up or down surpluses & shortages are created, but surpluses & shortages are created, but competition will again lead to an equilibriumcompetition will again lead to an equilibrium

Other Wage Determination Other Wage Determination TheoriesTheories

• Efficiency Wages - higher-than-Efficiency Wages - higher-than-competitive wage rates:competitive wage rates:– Workers have more incentive to be Workers have more incentive to be

productive so they can keep their higher productive so they can keep their higher paying jobpaying job

• Insiders Versus Outsiders:Insiders Versus Outsiders:– Current employees “with pull” create Current employees “with pull” create

barriers to entry for outsiders who are barriers to entry for outsiders who are willing to work for lower real wageswilling to work for lower real wages

Shifts in Market Demand & Shifts in Market Demand & Supply of LaborSupply of Labor• Demand Curve Shifts:Demand Curve Shifts:

– ∆ ∆ in demand for final product shifts that market in demand for final product shifts that market DC for labor in the same directionDC for labor in the same direction

– ∆ ∆ in labor productivity shifts the labor DC in the in labor productivity shifts the labor DC in the same direction, due to more capital, same direction, due to more capital, technological improvements, etc.technological improvements, etc.

– ∆ ∆ in P of a substitute input will cause demand in P of a substitute input will cause demand for labor to ∆ in same directionfor labor to ∆ in same direction

– ∆ ∆ in P of complementary input will cause the D in P of complementary input will cause the D for labor to ∆ in opposite directionfor labor to ∆ in opposite direction

• Supply of Labor Determinants:Supply of Labor Determinants:– ∆ ∆ in wage rates of another industryin wage rates of another industry– ∆ ∆ in working conditions in an industryin working conditions in an industry– Job flexibilityJob flexibility

Monopoly in the Product Monopoly in the Product MarketMarket• For anything other than PC the DC for its For anything other than PC the DC for its

product is downward slopingproduct is downward sloping

– P must fall to sell moreP must fall to sell more– MR is continuously fallingMR is continuously falling– Monopolist will continue to product as long as Monopolist will continue to product as long as

additional profits are made, despite hiring additional profits are made, despite hiring more workersmore workers• Until wage rate = add.’l revenues (MRP)Until wage rate = add.’l revenues (MRP)

– Monopolists hire fewer workers b/c they must Monopolists hire fewer workers b/c they must account for declining product priceaccount for declining product price

Profit Maximization – Cost Profit Maximization – Cost MinimizationMinimization• Profit-maximizing combination of Profit-maximizing combination of

resources:resources:– MRP of labor = price of laborMRP of labor = price of labor– MRP of capital = price of capitalMRP of capital = price of capital– MRP of land = price of landMRP of land = price of land

• Cost minimization:Cost minimization:– MPP of labor MPP of labor = = MPP of capital MPP of capital = = MPP of landMPP of land

price of labor price of capital price of landprice of labor price of capital price of land