Labour Economics

Introduction

• Labour economics is the study of the market for labour services in the economy

• The actors in the labour market includes;Households Firms Government

• The interactions between these players in the labour market determines;

I.equilibrium price- the wage that workers receive

II.equilibrium quantity- the amount of work that the people

do in the economy

Labour Demand

• Labour demand is the need for employees and workers in particular job in given time

• The demand for labour comes from the employees

Factors affect for labour demandI. Wage rateII. Unit cost of capitalIII. Selling price of output

Profit maximization

• Economic profit = TR - TC• By adding a worker;

TR TC

• A firm will add more labor if; TR > TC

Marginal Revenue ProductionMPR is the additional revenue that results from the use of an additional unit of labor

MRP = TRL

Assumptions of marginal revenue productivity

1. Workers are homogeneous in terms of their ability and productivity

2. Trade unions have no impact on the available labour supply

3. Firms have no buying power when demanding workers

4. The physical productivity of each worker can be accurately and objectively measured

5. Workers can be hired at a constant wage rate

Marginal Factor Cost (MFC)

• MFC is the additional cost associated with the use of an additional unit of labor

MFC = TC L

MRP, MFC & Profit Maximization

• A firm will use more labor if MRP > MFC

• A firm will use less labor if MRP < MFC

• A firm maximizes its profit at the level of labor use at which MRP = MFC

Labour Output (Q)

MP price ($) MRP ($) MFC ($)

Hire or not

0 0 - 10 -

1 5 5 10 50 20 Hire

2 12 7 10 70 20 Hire

3 16 4 10 40 20 Hire

4 17 1 10 10 20 Not hire

5 15 -2 -- -- --

Derivation of MRP curveMRP = TR

LMRP = MR MP

MR = TR MP = Q Q L

MRP = TR = TR Q L Q L

Derivation of MRP curve cont’ – MP curve

MP

Quantity of Labor

Derivation of MRP curve cont’ – MR curve

• Perfect Competition

P = MR = AR

MR

Quantity of output

MRP curve

MRP

Quantity of Labor

MRP curve =Demand Curve

Law of Diminishing of Returns

• Every additional unit of labor will yield a higher MR for a while

• Eventually MR starts to increase at a decreasing rate

• Then MRP = MFC• Finally MR decreases

Derivation of MFC curve

• In a perfectly competitive labor market, MFC = w

Real

Wag

e Ra

te

Units of labour

MFC = w

Short run Labour Demand Curve in a Perfectly Competitive Market

Real

Wag

e Ra

te

L3L2L1

W

Units of labour

MFC = w

Real

Wag

e Ra

te

Units of labour

MFC1

L3L2L1

MFC2

MFC3

W2

W1

W3

Short run Labour Demand Curve in a Perfectly Competitive Market

W2

Demand for LabourRe

al W

age

Rate

W3

W1

Units of labourL3L2L1

MRP curve =Demand Curve

Real

Wag

e Ra

te

Units of labour

Shifts in demand curve

E0

W0

L0

D0

D1

D3

L2 L1

S

W1

W2

Rightward shift of demand curve due to; Increase in labour productivity Higher demand for the final product Lower price of a substitute input (capital)

Leftward shift of demand curve due to;Decrease in labour productivityLower demand for the final productHigher price of a substitute input (capital)

Labour Supply

• Supply of labor is the total hours (adjusted for intensity of effort) that workers wish to work at a given real wage rate

Basic concepts: measures and definitions

• Employed (E) : if a person works for pay for more than one hour per week

• Unemployed (U) : if a person must have used at least one active method to look for a job in the last four weeks

or the person must be willing to start a job and able

to take one up within two weeks if offered one

• Labour Force (LF) = employed(active) + Unemployed(active)

• Individuals who are neither employed or unemployed called inactive or out of the labour force (NLF)

• These include pensioners, students and those who serve in the military in the countries with compulsory draft

• Working age population (P) = LF + NLF

• Unemployment rate = the ratio between the total number of unemployed and those in the labour force

ur = U/LF

• Labour market performance;lfpr = LF/P

• Employment to population rate = ratio of total employment to total working age population

epr = E/P

Supply CurveRe

al W

age

Rate

Units of labour

W3

W2

W1

L1 L2 L3

Supply Curve

Factor affecting on labour supply

Workers decide whether, to work or not to wor & time of work

It depends on the income & leisure There are two effects on labour supply

1.Substitution effect2.Income effect

Substitution effect

IC2

IC1

No of leisure hrs per period of time

Income per period of time

Y1

Y2

A

B

X 0

YA

YB

XA XB

Income Effect

IC2

IC1

No of leisure hrs per period of time

Income per period of time

Y1

Y2

A

B

X

YA

YC

YB

XA XB XC

C

• Higher wages attract labours to work more • Because it makes more money• As the wage rate rises, there are two things

going on…

1. Substitution effect Worker will offer himself for more hours The price of 'leisure' has become relatively expensive So the worker will substitute 'leisure' hours

for 'work' hours It always have a positive relationship

2. Income effectHigher wages lead to an increment of the

individual's real income Some people continue to earn high

amount of moneyBut majority wants to spend more leisure

time since they have enough moneyDemand for leisure starts to riseAs a result, demand for working hours

decreases

Backward bending supply curve of labourRe

al W

age

Rate

W

W 1

W2

XX1 X2

Substitution effect

Income effect

Units of labour

Market EquilibriumRe

al W

age

Rate

Units of labour

W0

L0

E0

Supply curve

Demand curve

Monopsony

• A labor market in which there is only one firm demanding labor is called a monopsony

• The single firm in the market is referred to as the monopsonist

Supply curve facing a monopsonist

Real

Wag

e Ra

te

Units of labour

MFC

S

A monopsony firm faces the entire market labor supply curveMFC > w

Wage & Employment determination under a monopsony

Real

Wag

e Ra

teMFC

S

MRP

W0

Units of labourL0

Trade union in a monopsony

Real

Wag

e Ra

te

Units of labour

W0

L0

W1

L1

S

MRP

MFC

Trade union in a monopsony

Real

Wag

e Ra

te

Units of labour

W0

L0

W1

L1

MFC

S

MRP

Minimum wage in a monopsony

Real

Wag

e Ra

te

Units of labour

W0

L0

W1

L1

MFC

S

MRP

Unemployment

Real

Wag

e Ra

te

Units of labour

W0

L0

E0

S

D1

W1

L S

D2

E1

L D

Surplus of workers (unemployment)

W0

L0

Real

Wag

e Ra

te

Units of labour

W2

Ls

D1D2

E0

S

Labour Shortage

L D

Shortage

L D

Group Members

D.N. Nanayakkara UWU/EAG/11/0028 K.H.M.A.P. Kariyawasam UWU/EAG/11/0006

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