Chap 010

Chapter 10: Wage Determination

Firm’s Demand for Labor  • Labor is the most important of the resources used by firms. • Labor demand is a d e r i v ed d e m a n d ,  thus it depends on • the productivity of labor • the price of the good or service it helps produce D er i v e d d e m a n d    is the demand for a resource that

results from the demand for the product it helps produce. LO: 10-1

Marginal Revenue Product and Marginal Revenue Cost • Marginal revenue product  (MRP) of labor is the change in a firm’s total revenue when it employs one more unit of labor. • Marginal resource cost (MRC) of labor is the change in a firm’s total cost when it employs one more unit of labor. •

In a competitive labor market MRC is equal to market wage rate. Change in total revenue

MRP =

MRC = Unit change in labor

LO: 10-1

Change in total cost Unit change in labor

Marginal Revenue Product of Labor as Labor Demand Schedule • MRP = MRC can be written as MRP = wage rate. • The MRP schedule therefore constitutes the firm’s demand for labor • because each point on this schedule (or curve) indicates the quantity of labor units that the firm would hire at each possible wage rate.

• The market demand for labor is the horizontal summation of all the individual firm demand curves for labor. LO: 10-1

Changes in Labor Demand The labor demand curve can shift if there are: • Changes in product demand: higher product demand  – higher labor demand. • Changes in productivity: higher productivity of labor  – higher labor demand . Productivity depends on: • Quantity of other resources • Technological advance • Quality of labor

• Changes in the prices of other resources: • a decline in price of complementary resources increases labor demand • a change in price of substitute resources has an ambiguous effect on labor demand LO: 10-2

Elasticity of Labor Demand • E las t i c i t y o f L ab o r D em an d (Ew) is a measure of the responsiveness of employers to a change in the wage rate. • It is also called wage elasticity of demand. • Ew < 1: labor demand is inelastic  • Ew > 1: labor demand is elastic  • Ew = 1: labor demand is unit-elastic  Ew = LO: 10-3

Percentage change in labor quantity Percentage change in the wage rate

Changes in Elasticity of Labor Demand Wage elasticity of demand depends on: • Ease of resource substitutability: the greater the substitutability, the more elastic is the labor demand  • Elasticity of product demand: the greater the elasticity of product demand, the greater the elasticity of labor demand  • Ratio of labor cost to total cost: the larger the share of labor in total cost, the greater the elasticity of labor demand  LO: 10-3

Market Supply of Labor • The supply curve for each type of labor slopes upward, indicating that firms must pay a higher wage rate in order to attract workers away from the alternative job opportunities available to them and workers not in the labor force. • The intersection of labor supply and labor demand determines the equilibrium wage rate and level of employment in a given labor market. LO: 10-4

Competitive Labor Market • Many employers compete for a specific type of labor. • Many workers with identical skills supply that type of labor. • Individual employers are “wage takers.” • An individual firm’s labor supply is perfectly elastic at the market wage rate.

• Firms use the MRP = MRC rule to determine employment at market wage. LO: 10-4

Competitive Labor Market Labor Market S

   )   s   r   a    l    l   o    D    (   e($10)    t   a WC    R   e   g   a    W

0

D=MRP (∑ m r p s )  Q C (1000)

Quantity of Labor

LO: 10-4

Individual Firm    )   s   r   a    l    l   o    D    (   e($10)    t   a WC    R   e   g   a    W

0

s =  MRC

d=mrp q C (5)

Quantity of Labor

Monopsony • In labor market m o n o p s o n y , the single employer is a “wage maker.” • A monopsonist’s labor supply curve is the same as the market labor supply curve and is upward-sloping. • The MRC curve lies above the labor supply curve and MRC exceeds the wage rate. •  A monopsonist will use the MRP = MRC rule to determine the quantity of labor to hire and the pay wage corresponding to this quantity supplied.  A M o n o p s o n y    is a market structure in which there is only a single buyer of a good, service, or resource. LO: 10-4

Monopsony MRC

In a monopsony, employment and wage are lower than in a competitive labor market

   )   s   r   a    l    l   o    D    (   e W     t   a c    R   e W m   g   a    W

0

S

b a c

MRP

Q m

Q c

Quantity of Labor LO: 10-4

Union Models • In some labor markets, workers sell their labor services collectively through labor unions. • Unions work to raise wage rates for their members. Exclusive (craft) unions • Restrict supply of skilled labor to increase the wage rate received by union members

LO: 10-4

Inclusive (industrial) unions • Include all workers in an industry as members • put great pressure on firms to agree to their wage demands through the threat of a strike

Craft Union Model S  2

   )   s   r   a    l    l   o    D    (   e    t   a    R   e   g   a    W

S  1

Decrease In Supply

W  u W c

D  Q u

Q c

Quantity of Labor LO: 10-5

Industrial Union Model S 

   )   s   r   a    l    l   o    D    (   e    t   a    R   e   g   a    W

W u

a

b e

W c

D  Q u

Q c

Q e

Quantity of Labor LO: 10-5

Wage Differentials • Wage d ifferentials  are the differences between the wages of different groups of workers. • Wage differentials can arise either on the demand or the supply side of labor markets. •  A weak labor demand will result in a low equilibrium wage but a strong labor demand will result in a high equilibrium wage. •  A low labor supply will result in a high equilibrium wage while a higher labor supply results in a low equilibrium wage. • Members of noncompeting groups differ in their mental and physical abilities and in their level of education and training and therefore, receive different compensation. LO: 10-6