Introduction: Thinking Like an Economist 1 CHAPTER Work and the Labor Market Work banishes those...

Introduction: Thinking Like an Economist

1CHAPTER

Work and the Labor Market

Work banishes those three great evils: boredom, vice, and poverty.

— Voltaire

CHAPTER

17

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

1Work and the Labor Market 1

7

17-2

Work and the Labor Market

A labor market is a factor market in which individuals supply labor services for wages to individuals and firms that demand labor services

Incentive effect is how much a person will change hours worked in response to the wage rate

The labor supply choice is between nonmarket activities and legal market activities

• Economists focus on the incentive effect when considering an individual’s choice of whether and how much to work


7

17-3

The Supply of Labor

The higher the wage, the higher the quantity of labor supplied.

The labor supply curve has a positive slope because the opportunity cost of not working increases as wages get higher

Wage Rate

Q of Labor

Supply of Labor


7

17-4

Real Wages and the Opportunity Cost of Work

The upward sloping labor supply curve tells you that, other things equal, as wages go up, the quantity of labor supplied goes up

This is explained by the income effect; higher incomes make people richer, and richer people can afford to choose more leisure causing a decrease in hours worked

Historically real wages have been increasing and people have reduced the number of hours they work, but they still work more hours than predicted


7

17-5

Income Tax, Work, and Leisure

Taxes reduce the net wage of individuals, reducing the incentive to work

For welfare recipients, the tax penalties for working create a great incentive to not work or to work “off the books”

An increase in the marginal tax rate is likely to reduce the quantity of labor supplied

EU countries, which have relatively high marginal tax rates, are struggling with the problem of providing incentives for people to work


7

17-6

The Elasticity of Labor Supply

Elasticity of labor supply depends on:• Individuals’ opportunity cost of working• The type of labor market being discussed• The elasticities of individuals’ supply curve• Individuals entering and leaving the labor market

Employees prefer an inelastic labor supply, but employers prefer an elastic labor supply

Estimates for labor supply elasticity are about 0.1 (inelastic) for heads of household and 1.1 (elastic) for secondary earners


7

17-7

Immigration and the International Supply of Labor

International limitations on the flow of people play an important role in elasticities of labor supply

Large differentials in wages mean that many people from low wage countries would like to move to high wage countries to earn higher wages

EU countries have open borders among member countries, allowing the flow of labor between low and high wage countries


7

17-8

The Derived Demand for Labor

The demand for labor follows the basic law of demand: the higher the wage, the lower the quantity of labor demanded

The demand for labor by firms is a derived demand meaning the demand for factors of production by firms depends on consumers’ demands

Wage Rate

Q of Labor

Demand for Labor


7

17-9

Factors Influencing the Elasticity of Demand for Labor

Four factors that influence the elasticity of demand for labor are:

• The elasticity of demand for the firm’s good

• The relative importance of labor in the production process

• The possibility, and cost, of substitution in production

• The degree to which the marginal productivity falls with an increase in labor


7

17-10

Labor as a Factor of Production

The traditional factors of production are land, labor, capital, and entrepreneurship

The labor market includes labor and entrepreneurship

Entrepreneurship refers to labor services that require high degrees of organizational skills, concern, oversight responsibility, and creativity

Days of entrepreneurship can be equivalent to weeks and months of non-entrepreneurial labor


7

17-11

•Rule for employing labor:

• MRP = MRC

MarginalRevenueProduct

=Change in Total Revenue

Unit Change in Resource Quantity

MarginalResource

Cost=

Change in Total (Resource) Cost

Unit Change in Resource Quantity

• Marginal Revenue Product (MRP)

• Marginal Resource Cost (MRC)


7

17-12

Re

so

urc

e W

ag

e(W

ag

e R

ate

)

Quantity of Resource Demanded

(1)Units of

Resource

(2)Total Product

(Output)

(3)Marginal

Product (MP)

(4)Product

Price

(5)Total Revenue,

(2) X (4)

(6)Marginal Revenue

Product (MRP)

01234567

07

131822252728

7654321

$22222222

$ 014263644505456

$141210

8642

]]]]]]]

]]]]]]]

1 2 3 4 5 6 7

0

-2

2

4

6

8

10

12

14

16

$18

D=MRP

PurelyCompetitiveFirm’sDemand forA Resource


7

17-13

($10)WC

($10)WC

Wag

e R

ate

(Do

llar

s)

Labor Market

Quantity of Labor

Wag

e R

ate

(Do

llar

s)

Individual Firm

Quantity of Labor

QC

(1000)

0 0

d=mrp

qC(5)

s=MRC

Competitive Labor Market

D=MRP(∑ mrp’s)

S

e b

a

c


7

17-14

Equilibrium in the Labor Market

Equilibrium is where the quantity demanded of labor is equal to the

quantity supplied

Wage Rate

Q of Labor

Demand for Labor

Supply of Labor

Qe

We

Equilibrium wage is We

Equilibrium quantity is Qe


7

17-15

Shift Factors of Demand

Technology both increases/decreases the demand for labor

International competitiveness may increase the demand for labor in the U.S. in spite of lower wages in foreign countries because:

• U.S. workers may be more productive• Transportation costs are lower• Potential trade restrictions• Production techniques are not compatible with foreign

social institutions• Focal point phenomenon is a situation where a

company moves to a country because others have already moved there


7

17-16

Determination of Wages

Supply and demand forces strongly influence wages, but they do not fully determine wages

Real-world labor markets are filled with examples of individuals or firms who resist these supply and demand pressures:

• Labor unions

• Professional associations

• Agreements among employers


7

17-17

Labor Market in Action

The effect of an above equilibrium wage is an

excess supply of labor and jobs must be rationed

Wage Rate

Q of Labor

Demand for Labor

Supply of Labor

QD

W1

QS

Excess supply of labor

We


7

17-18

Labor Market in Action

The effect of an increase in the supply

of labor will cause:

Wage Rate

Q of LaborD

S0

Q0

W1

Q1

W0

Equilibrium wage to decrease

Equilibrium quantity to increase

S1


7

17-19

The Labor Market and You

Consider relative pay of jobs requiring a college degree compared to jobs requiring only a high school diploma

Consider the salaries of Ph.D.s compared to the salaries of MBAs

Among jobs you like, choose a job in a field in which the supply of labor is limited, or the demand for labor is significantly increasing

Jobs in which the supply will likely be limited are those in which social or political forces have placed restrictions on entry or those requiring special abilities


7

17-20

Labor Demand

Consider relative pay of jobs requiring a college degree compared to jobs requiring only a high school diploma

Consider the salaries of Ph.D.s compared to the salaries of MBAs

Among jobs you like, choose a job in a field in which the supply of labor is limited, or the demand for labor is significantly increasing

Jobs in which the supply will likely be limited are those in which social or political forces have placed restrictions on entry or those requiring special abilities

Introduction: Thinking Like an Economist 1 CHAPTER Work and the Labor Market Work banishes those...

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