Chapter 16Chapter 16

Economics of the Labor Market

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning ObjectivesLearning Objectives

• Define the labor supply and demand curves.

• Identify factors affecting labor market equilibrium.

• Explain why different workers may receive different wages.

• Describe effects of government regulation on the labor market.

• Identify the factors driving long-term labor supply.

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Basics of the Labor MarketBasics of the Labor Market

• The labor market involves the buying and selling of the time and effort of different kinds of workers.

• The labor input is essential for all production activities.

• The labor market functions like other markets, meaning that the price of labor (wages) is set by supply and demand.

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Labor SupplyLabor Supply

• The labor force is the part of the adult population that is either working or actively looking for a job.

• An individual’s choice to be in the labor force or not is known as the labor force participation decision.

• The labor supply curve tells us, given the wage, how many people are in the labor force and looking for work.

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Labor DemandLabor Demand

• The labor demand curve shows how many workers businesses will want to hire at a given wage.

• In general, as the wage rises, businesses will want to hire fewer workers.

• The hiring decision depends on the marginal product and marginal cost of labor.

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Labor DemandLabor Demand

• The marginal product is the increased production or output that hiring an extra worker generates.

• The marginal cost is the wage the company pays the worker.

• To make the hiring decision, the manager compares the added revenue an extra worker brings in against the additional cost of hiring that worker.– A company will hire as long as marginal revenue

exceeds the wage.16-6

Labor Market Supply and Labor Market Supply and DemandDemand

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Example of Labor DemandExample of Labor Demand

• The first two columns of the table on the next slide show the production function.

• The marginal product is a measure of the productivity of each worker.

• Given the $20 price for haircuts, the total revenue is shown in column four.

• The firm hires three workers since this maximizes profits.

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Example of Labor DemandExample of Labor Demand

No. of Workers

No. of haircuts per day

Marginal product

Total revenue

Marginal revenue

Total labor cost

Marginal labor cost

Profit

1 6 6 $120 $120 $90 $90 $30

2 12 6 $240 $120 $180 $90 $60

3 17 5 $340 $100 $270 $90 $70

4 21 4 $420 $80 $360 $90 $60

5 24 3 $480 $60 $450 $90 $30

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Market EquilibriumMarket Equilibrium

• Wages are set by the interaction of supply and demand.– The market adjusts so that wages rise or

fall to the point where the quantity supplied for labor is equal to the quantity demanded for labor.

• Wages will change when there is a shift in either labor demand or labor supply.

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The Changing Market for The Changing Market for AccountantsAccountants

Original labor demand curve for accountants

L

W

New labor demand curve for accountants

Wage for accountants

L1

Number of employed accountants

Labor supply curve for accountants

W1

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The Impact of Technological The Impact of Technological ChangeChange

• Technological change can have a major impact on both the labor supply schedule and the labor demand schedule.

• Technology can either be a substitute for or a complement to labor. – Technology is a substitute for labor if it causes

the labor demand curve to shift to the right. – Technology is a complement to labor if it causes

the labor demand curve to shift to the left.

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The Impact of Technological The Impact of Technological ChangeChange

• Most recent technological innovations have acted as substitutes for low-skilled labor and complements to high-skilled labor.

• Thus, the speed of technological change has benefited educated workers who find it easier to adapt to new technologies.

• The big question is whether technological change will continue to favor educated workers.

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The Impact of GlobalizationThe Impact of Globalization

• Globalization and advances in communication technology make it possible for companies to hire workers across the country or around the world.

• Thus, labor markets have become national or even global in nature.

• It is not only low-skill jobs that are impacted, as many technology companies are doing much of their design work in Asia.

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The Impact of GlobalizationThe Impact of Globalization

• Globalization causes the supply curve to shift to the right because there is a larger pool of workers available globally. This is

the labor pool effect of globalization.– The labor pool effect causes wages in the

United States and other industrialized countries to fall because of competition from low-wage workers in developing countries.

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The Labor Pool Effect of The Labor Pool Effect of GlobalizationGlobalization

Demand curve

L1

W1

Supply curve for labor, including workers from other countries

Wages

L

Quantity of workers employed

Supply curve for labor (domestic only)

W

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The Impact of GlobalizationThe Impact of Globalization

• Besides its impact on labor supply, globalization also has an impact on labor demand.

• The market expansion effect of globalization has a positive impact on labor demand since U.S. companies now produce not just for the domestic market, but for overseas markets as well.– Globalization results in more customers and

sales, and thus more labor demand.

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The Market Expansion The Market Expansion Effect of GlobalizationEffect of Globalization

Demand curve for labor, based only on domestic sales

L

W

Demand curve for labor including overseas sales

Wages

L1

Quantity of workers employed by U.S. companies

Supply curve for labor

W1

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The Impact of GlobalizationThe Impact of Globalization

• The impact of globalization on wages depends on which factor is more important: the market expansion impact or the labor pool effect.– Wages will decline if the labor pool effect

is larger than the market expansion impact.

– Wages will rise if the market expansion impact is larger than the labor pool effect.

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Not All Workers Are the SameNot All Workers Are the Same

• Most labor markets are non-competing. – That is, workers in one market are not

competing for jobs in the others.• The labor market is really a collection of

many smaller labor markets, each with their own labor supply and demand curves.

• The lack of competition among the labor markets explains the differences in compensation among various occupations.

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EducationEducation

• One of the factors causing labor markets to be non-competing is the level of education.

• Education has become the key qualification that workers need.

• The education premium is the added pay for getting a college degree.– This is an important point because the

pay difference between workers with more education and workers with less education has been widening over time.

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Inflation-Adjusted Earnings by Inflation-Adjusted Earnings by Education LevelEducation Level

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Age and ExperienceAge and Experience

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Regulation of the Labor MarketRegulation of the Labor Market

• The labor market is highly regulated.• One form of regulation is the minimum

wage, which sets a floor for hourly wages for most workers.

• A minimum wage lifts the wages of the lowest-paid workers above the market wage.

• As a result, employers have to cut back on their hiring since the marginal revenue of some workers is now below their wage.

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Labor Supply and Demand with Labor Supply and Demand with a Minimum Wagea Minimum Wage

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Regulation of the Labor MarketRegulation of the Labor Market

• The length of the work day and work week is also regulated.

• The government also sets licensing requirements for certain professions, such as doctors and pharmacists.

• A union is a group of workers who bargain collectively with employers for wages (including benefits) and working conditions.

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Regulation of the Labor MarketRegulation of the Labor Market

• Wage-setting with collective bargaining is very different from wage-setting in a competitive market.

• Bargaining takes place against a backdrop of laws and regulations that determine what is acceptable. – Compliance is monitored by the National

Labor Relations Board, whose members are appointed by the President.

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The Impact of Union The Impact of Union Membership on WagesMembership on Wages

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Long-term Labor SupplyLong-term Labor Supply

• The long-term labor supply is the predicted size of the labor force in a country some time in the future.

• The long-term labor supply is important because it affects the growth rate of the economy, future tax revenues, and the ability of businesses to find workers.

• Long-term labor supply is projected by looking at the growth in the working age population.

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Long-term Labor SupplyLong-term Labor Supply

• Long-term labor supply depends on the birth rate and the number of immigrants from other countries.

• Immigration increases the growth rate of the labor force and shifts the labor supply to the right.

• Immigration is a highly controversial issue.• Long-term labor supply is affected by people

moving from one area of the country to another.

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