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Lecture 11
Markets for Labor
How can we explain wage differences?
• Oprah Winfrey has made $260 million per year• An aerospace engineer in the U.S. receives $89,000
on average per year• A preschool teacher receives $26,000 on average
per year• What causes these differences? Can we explain
them with differences in productivity?
Labor productivity
• Demand for labor is related to the productivity of the labor
• Main contributors to variations in labor productivity:– The skills of the workers– The efficiency with which workers apply their skills– The level of effort with which workers work– The quantity and the characteristics of the resources
available to each worker
Labor supply
• What is the opportunity cost of paid employment?
The opportunity cost of engaging in paid work is the highest value of the time that might otherwise have been spent in alternative uses such as:– Household production– Education– Self-employment– Leisure
Labor supply
• What is the benefit of paid employment?– Wages and salaries (extrinsic motivations)– Work experience itself (intrinsic motivation)
• Labor force participation:The percentage of the adult population who are either
working at a paid job or seeking paid work
Individual labor supply• Assumptions:
– The worker can find a job that meets his/her desires
– There is only one kind of paid job– The job has no intrinsic motivation
Quantity of Labor
Wa
ge
(pr
ice
of
lab
or
$)
Supply of Labor
Individual labor supply
Quantity of Labor
Wa
ge
(pr
ice
of
lab
or
$)
Supply of Labor
Quantity of LaborW
ag
e (
pric
e o
f la
bo
r$
)
Supply of Labor
Substitution effectis stronger
Income effectis stronger
An upward-sloping individual supply curve for labor
A backward-bending individual supply curve for labor
Market labor supply
Quantity of Labor
Wa
ge
(pr
ice
of
lab
or
$)
Supply of Labor
Market labor demand
• Demand curve for labor is downward-sloping:
– When wages are high, employers have incentives to economize on the use of labor
– When wages are low, employers may be able to expand their productive activities or substitute relatively cheap labor for other inputs
Labor market adjustment
Quantity of Labor
Q2
W2
W1
Q1
Wa
ge
($
)S
D1
E1
E2
Labor in traditional neoclassical model
Labor in traditional neoclassical model
• Example: A firm producing disposable razors
Labor in traditional neoclassical modelQ
ua
ntit
y o
f R
azo
rs
0
5
10
15
20
25
30
35
987654321
Quantity of Labor (number of workers)
Total Product Curve
Labor in traditional neoclassical modelC
ost
an
d R
even
ue
($
)
0
3
6
9
12
15
18
24
21
987654321
Quantity of Labor (number of workers)
MFCL
MRPL
Explaining variations in wages• Market forces and observable productivity differences are
only part of the explanation of variation in wages.
• Other potential sources for variation: – Human capital– Market power (See the case for monopsony!)– Compensating wage differentials– Worker motivation
• Efficiency wages• Employee morale• Dual labor markets
– Discrimination