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The Labor Market. Product Markets. Markets in which firms sell goods and services to households or other firms Products made from the economy’s resources. Factor Markets. Markets in which resources are sold to firms Resources include Capital, land, labor, and natural resources

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Product markets
Product Markets

  • Markets in which firms sell goods and services to households or other firms

  • Products made from the economy’s resources


Factor markets
Factor Markets

  • Markets in which resources are sold to firms

    • Resources include

      • Capital, land, labor, and natural resources

  • Resources are sometimes called factors of production



Labor markets in particular
Labor Markets in Particular

  • Determining a worker’s wage rate

    • Groups of economic decision makers come together in markets in order to trade

    • Each decision maker tries to maximize something and faces constraints

    • Observe equilibrium price determined in those markets

    • Explore how various changes affect that equilibrium price


Special meaning
Special Meaning

  • The special meaning of the price in the labor market—the wage rate

    • Income people earn over their lifetime will determine how they will be able to provide for themselves and their families

    • Adds a special moral dimension to events in labor markets


Defining a labor market
Defining a Labor Market

  • How broadly or narrowly we define a market depends on the specific questions we wish to answer

    • Broadly defined markets may look at markets that draw on labor from all over the world

    • Narrowly defined markets may look at markets that draw on labor on a very localized level


Competitive labor markets
Competitive Labor Markets

  • Market with many indistinguishable sellers of labor and many buyers

    • Involves no barriers to entry or exit

    • Perfectly competitive labor markets must satisfy three conditions

      • Great many buyers (firms) and sellers (households) of labor in market

      • All workers in market appear the same to firms

      • No barriers to entering or leaving labor market


Firms in labor markets
Firms in Labor Markets

  • Sometimes firms that compete in the same product market also compete in the same labor markets, but

    • Some firms that compete in the same product market operate in different labor markets

    • Some firms that operate in different product markets compete in the same labor market

  • The demand side of a labor market includes all firms hiring labor in that labor market

    • These firms may (but not necessarily) compete in the same product market


Derived demand
Derived Demand

  • The demand for labor is a derived demand―it arises from, and will vary with—the demand for the firm’s output

    • The phrase “will vary with” is important

      • The demand for labor by a firm will change whenever demand for the firm’s product changes


Resource demand a general rule
Resource Demand: A General Rule

  • Marginal approach to profit

    • Firm should take any action that adds more to its revenue than it adds to its cost

  • When we view firm as a buyer in a resource or factor market, we use same principle of marginal decision making

    • This time action under consideration is “increase employment of the resource by another unit”

    • Rule becomes

      • Increase employment of any resource whenever doing so adds more to revenue than it adds to cost

    • To avoid confusion between decisions about resources and decisions about output, we don’t use terms “marginal revenue” and “marginal cost” when discussing factor markets

      • To track changes on the revenue side, use term “marginal revenue product”


Marginal revenue product mrp
Marginal Revenue Product (MRP)

  • The change in firm’s total revenue divided by change in its employment of a resource

  • When firm thinks about changing resource by one unit at a time

    • MRP is the change in the firm’s revenue when it employs one more unit of the resource


Marginal factor cost mfc
Marginal Factor Cost (MFC)

  • To track changes on the cost side, we use the term marginal factor cost

  • The MFC tells us the rise in cost per unit increase in the resource

  • When Δ Quantity of Resource = 1 MFC is increase in cost from employing one more unit of resource


  • Marginal approach to profit
    Marginal Approach to Profit

    • To maximize profit firm should increase its employment of any resource whenever MRP > MFC

      • But not when MRP < MFC

    • Profit-maximizing quantity of any resource is quantity at which MRP = MFC

    • If MRP >MFC, employing more of resource increases revenue more than cost

      • Profit will rise

    • When MRP <MFC, using more of resource adds more to cost than to revenue

      • Profit falls

    • When firm exploits every opportunity to increase profit it will arrive at the point at which MRP =MFC


    The firm s employment decision when only labor is variable
    The Firm’s Employment Decision When Only Labor Is Variable

    • The Firm’s MRP in a Competitive Product Market

      • When output is sold in a competitive product market

        • MRP for any change in employment will equal price of output (P) times marginal product of labor (MPL)

          • MRP = P x MPL

    • The Firm’s MFC in a Competitive Labor Market

      • When labor is hired in a competitive labor market, MFC for any change in employment will equal market wage rate (W)

        • MFC = W


    The profit maximizing employment level
    The Profit-Maximizing Employment Level

    • Marginal approach to profit

      • A firm should take any action that adds more to its revenue than to its cost

    • Hire another worker when MRP > W, but not when MRP < W

    • To maximize profit, the firm should hire the number of workers such that MRP = W

      • Where the MRP curve intersects the wage line


    The profit maximizing employment level1

    Dollars

    $200

    150

    100

    Wage

    60

    50

    MRP

    1

    2

    3

    4

    5

    6

    7

    8

    Number

    of Workers

    The Profit-Maximizing Employment Level


    The two approaches to profit maximization
    The Two Approaches to Profit Maximization

    • Two different approaches for the firm to follow to maximize profit

      • MR and MC approach to find profit-maximizing output

      • MRP and MFC approach to find profit-maximizing employment

    • Can these two approaches lead to different decisions?

      • No, because these two “different” approaches are actually the same method viewed in two different ways

      • Remember that hiring another worker increases the firm’s output and therefore changes both its revenue and its cost

    • Whenever MRP > MFC for a change in employment, MR > MC for associated rise in output

    • Whenever MRP < MFC for a change in employment, MR < MC for associated rise in output

    • If MRP = MFC for a change in employment, MR = MC for associated change in output


    The firm s labor demand curve
    The Firm’s Labor Demand Curve

    • When labor is the only variable input, downward-sloping portion of MRP curve is firm’s labor demand curve

      • Tells us how much labor firm will want to employ at each wage rate


    The firm s labor demand curve1

    Firm’s

    Dollars

    Labor Demand

    A

    Curve

    W

    1

    W

    1

    B

    W

    2

    W

    2

    Number

    of Workers

    n

    n

    1

    2

    The Firm’s Labor Demand Curve


    The firm s employment decision when several inputs are variable
    The Firm’s Employment Decision When Several Inputs are Variable

    • Whether the firm can vary just labor, or several inputs simultaneously

      • Optimal level of employment will satisfy the MRP = W rule

    • Firm’s labor demand curve will slope downward

    • Decrease in wage rate will cause an increase in employment


    The employment decision with several variable inputs

    Dollars Variable

    A

    W

    W

    1

    1

    B

    C

    W

    W

    2

    2

    Firm’s

    Labor

    MRP

    MRP

    2

    Demand

    1

    Curve

    Number

    of Workers

    n

    n

    n

    1

    2

    3

    The Employment Decision with Several Variable Inputs


    The market demand for labor
    The Market Demand For Labor Variable

    • Market Labor Demand Curve

      • Indicates total number of workers all firms in a labor market want to employ at each wage rate

      • Found by horizontally summing across all firms’ individual labor demand curves



    A shift in the labor demand curve

    (b) Variable

    Labor Market

    Hourly

    Wage

    A

    B

    A

    B

    D

    D

    d

    l

    d

    L

    l

    L

    2

    2

    1

    1

    N

    N

    Number

    1

    2

    of Workers

    A Shift in the Labor Demand Curve

    (a)

    Typical Firm

    Hourly

    Wage

    $10

    n

    n

    Number

    1

    2

    of Workers


    Shifts in the market labor demand curve
    Shifts in the Market Labor Demand Curve Variable

    • A change in any variable that affects quantity of labor demanded—except for the wage rate—causes labor demand curve to shift

    • Specific variables that shift the labor demand curve include a change in

      • Demand for the firm’s product

      • Technology

      • Prince of another input

      • Number of firms


    A change in demand for the firm s output
    A Change in Demand for the Firm’s Output Variable

    • Effect of a change in output price on labor demand depends on whether many firms in the labor market also share the same product market

    • When they do

      • A rise in output price will shift market labor demand curve rightward

      • A fall in output price will shift market labor demand curve leftward


    A change in technology
    A Change in Technology Variable

    • Complementary Input

      • An input whose utilization increases marginal product of another input

    • Substitute Input

      • An input whose utilization decreasesmarginal product of another input


    A change in technology1
    A Change in Technology Variable

    • When many firms in a labor market acquire a new technology, the market labor demand curve will shift

      • Rightward if technology is complementary with labor

      • Leftward if technology is substitutable for labor


    Introducing a new input

    Hourly Variable

    Wage

    d

    l

    1

    Number

    of Workers

    Introducing a New Input

    More

    of a

    More

    Complementary

    of a

    Input

    Substitutable

    Input

    d

    l

    2

    d

    l

    3


    A change in the price of another input
    A Change in the Price of Another Input Variable

    • When price of some other input decreases, market labor demand curve may shift

      • Rightward if the input is complementary with labor

      • Leftward if the input is substitutable for labor


    Individual labor supply
    Individual Labor Supply Variable

    • Individuals as wage takers

      • No single labor seller can affect the market wage

      • In a competitive labor market

        • Each seller is a wage taker

          • He or she takes market wage rate as given


    The income leisure trade off
    The Income-Leisure Trade-off Variable

    • Wage rate determines exact nature of the income-leisure trade-off

      • Higher the income »» higher the expense of leisure time


    The labor supply decision
    The Labor Supply Decision Variable

    • Individuals who are able to choose their own hours may

      • Choose optimal combination of income and leisure

    • Individuals who are not able to choose their own hours

      • Only make the choice of whether to offer their labor in a particular market or not


    Reservation wages
    Reservation Wages Variable

    • Lowest wage rate at which an individual would supply labor to a particular labor market

    • When wage rate in a market exceeds an individual’s reservation wage for that market

      • Individual will decide to work there


    Market labor supply
    Market Labor Supply Variable

    • Curve indicating the number of people who want jobs in a labor market at each wage rate

      • The higher the wage rate, the greater the quantity of labor supplied


    Figure 8 the market labor supply curve
    Figure 8: The Market VariableLabor Supply Curve


    Shifts in the market labor supply curve
    Shifts in the Market Labor Supply Curve Variable

    • A market labor supply curve will shift when

      • Something other than a change in wage rate causes a change in number of people who want to work in a particular market

    • Factors causing a labor supply curve to shift include

      • Change in market wage rate in other labor markets

      • Changes in cost of acquiring human capital

      • Number of qualified people

      • Changes in tastes


    A change in the market wage rate in other labor markets
    A Change in the Market Wage Rate in Other Labor Markets Variable

    • As long as some individuals can choose to supply their labor in two different markets

      • A rise in wage rate in one market will cause a leftward shift in labor supply curve in other market


    Changes in the cost of acquiring human capital
    Changes in the Cost of Acquiring Human Capital Variable

    • An increase in the cost of acquiring human capital will shift the labor supply curve leftward

    • A decrease in the cost of acquiring human capital will shift the labor supply curve rightward


    Number of qualified people
    Number of Qualified People Variable

    • Population growth causes labor supply curves in both national and local labor market to shift rightward over time

    • Labor supply curves can also shift due to migration within a country

    • If new people entering a field exceeds number of retirees in that field

      • Increase in supply results


    Changes in tastes
    Changes in Tastes Variable

    • Different types of jobs attract different people with different tastes

      • Danger and excitement vs. safety and routine

    • Women entering the workforce

    • Social contribution to community


    Short run vs long run labor supply
    Short-Run vs. Long-Run Labor Supply Variable

    • Short-run

      • Labor supply response to a wage-rate change comes from those who already have skills and geographic location needed to work in a market

    • Long-run

      • Labor supply response to a wage-rate change comes from those who will acquire skills and move into geographic location needed to work in a market


    Short run vs long run labor supply1
    Short-Run vs. Long-Run Labor Supply Variable

    • Long-run labor supply curve indicates how many (qualified) people will want to work in a labor market

      • After full adjustment to a change in the wage rate

    • Long-run labor supply response is more wage elastic than short-run labor supply response


    The long run labor supply curve

    Hourly Variable

    Wage

    S

    S

    S

    L

    L

    L

    1

    2

    LR

    $40

    B

    C

    25

    A

    30,000

    60,000

    90,000

    Number of Workers

    The Long-Run Labor Supply Curve


    Labor market equilibrium
    Labor Market Equilibrium Variable

    • Supply and demand will drive a competitive labor market to its equilibrium point

      • Point where the labor supply and labor demand curves intersect



    What happens when things change
    What Happens When Things Change? Variable

    • Events that can cause labor demand curve and labor supply curve to shift include

      • Change in labor demand

      • Change in labor supply

      • Labor shortages and surpluses


    A change in labor demand
    A Change in Labor Demand Variable

    • In short-run, shift in labor demand moves along a short-run labor supply curve

    • In long-run, resulting increase in wage rate will cause short-run labor supply curve to shift also


    A change in labor demand1

    Labor Market Variable

    Typical Firm

    Dollars

    Wage

    S

    L

    1

    S

    L

    $40

    $40

    2

    B

    b

    W

    2

    30

    30

    c

    C

    W

    3

    20

    20

    D

    a

    A

    L

    2

    W

    1

    d

    l

    2

    d

    l

    D

    1

    L

    1

    5,000

    8,000

    12,000

    50

    80

    120

    Number

    Number

    of Workers

    of Workers

    A Change in Labor Demand


    Change in labor supply
    Change in Labor Supply Variable

    • Shifts in labor supply typically happen slowly

    • When a long-run change in labor supply is the cause of changes in the labor market

      • No separate short-run change in equilibrium to investigate


    The market for finance professors 1995 2002

    Annual Variable

    S

    L

    Wage

    2

    S

    L

    B

    1

    $91,200

    66,900

    A

    D

    L

    2

    D

    L

    1

    Number

    N

    N

    2

    1

    of New Finance

    The Market For Finance Professors (1995-2002)


    Labor shortages and surpluses
    Labor Shortages and Surpluses Variable

    • Labor Shortage

      • Quantity of labor demanded exceeds quantitysupplied at prevailing wage rate

    • Labor Surplus

      • Quantity of labor supplied exceeds quantitydemanded at prevailing wage rate


    Labor shortages and surpluses1
    Labor Shortages and Surpluses Variable

    • Shortages and surpluses in a labor market are not natural consequence of shifts in supply and demand curves

      • Labor shortage will occur only when wage rate fails to rise to its equilibrium value

      • Labor surplus will occur only when wage rate fails to fall to its equilibrium value


    Using the theory understanding the market for college educated labor
    Using the Theory: Understanding the Market for College-Educated Labor

    • Students have many motives for attending college

    • One of the most important motives is to invest in their own human capital

      • Going to college will enable you to earn a higher income than you would otherwise be able to earn

      • Economists track the college wage premium

        • Percentage by which average college graduate’s income exceeds average high school graduate’s income

          • Wage premium was relatively stable in 1960s and 1970s, at around 40 to 50%

          • But premium began to rise sharply in 1980s and continued its rise through 1990s

          • By 2001 college wage premium reached 76% for men and 97% for women


    Using the theory understanding the market for college educated labor1
    Using the Theory: Understanding the Market for College-Educated Labor

    • Why did labor supply shift rightward each year?

      • An increase in proportion of young people attending college

      • Population itself increased

    • Why did labor demand curve shift rightward each year?

      • Partly due to normal growth in economy

      • Technological change

        • Increase skill requirements for many types of work



    Using the theory understanding the market for college educated labor2
    Using the Theory: Understanding the Market for College-Educated Labor

    • An increase in yearly wage rate has resulted over last two decades

      • Because demand curve for college graduates shifted rightward faster than supply curve

    • What will happen in the future?

      • Competing trends

        • Acceleration in rightward shift of labor supply curve for college graduates

          • Will work to decrease college wage premium

        • Acceleration in rightward shift of labor demand curve for college graduates

          • Due to further changes in technology


    Using the theory understanding the market for college educated labor3
    Using the Theory: Understanding the Market for College-Educated Labor

    • Most labor market economists predict

      • For college-educated labor

        • Labor demand curve will shift rightward more rapidly than labor supply curve over next several years

        • Wage rate for college graduates is expected to rise

      • For high school graduates

        • Shifts in labor supply curve are expected to outpace shifts in demand curve

          • Wage premium for college students is expected to increase


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