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C hapter 15. Wage Rates in Competitive Labor Markets. Economic Principles. Marginal physical product of labor Marginal revenue product The law of diminishing returns Marginal labor cost The profit-maximizing level of employment . Economic Principles. Firm and industry demand for labor

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c hapter 15

Chapter 15

Wage Rates in Competitive Labor Markets

economic principles
Economic Principles
  • Marginal physical product of labor
  • Marginal revenue product
  • The law of diminishing returns
  • Marginal labor cost
  • The profit-maximizing level of employment

Gottheil - Principles of Economics, 4e

economic principles3
Economic Principles
  • Firm and industry demand for labor
  • The supply of labor
  • The backward-bending supply curve of labor
  • Wage differentials
  • Minimum wage laws

Gottheil - Principles of Economics, 4e

you load sixteen tons and what do you get
You Load Sixteen Tons and What Do You Get?

Marginal physical product (MPP)

  • The change in output that results from adding one more unit of a resource, such as labor, to production. MPP is expressed in physical units, such as tons of coal, bushels of wheat, or number of automobiles.

Gottheil - Principles of Economics, 4e

you load sixteen tons and what do you get5
You Load Sixteen Tons and What Do You Get?

Marginal physical product (MPP)

  • MPP = change in output (Q) divided by change in the number of people employed (L).

Gottheil - Principles of Economics, 4e

you load sixteen tons and what do you get6
You Load Sixteen Tons and What Do You Get?

Marginal physical product (MPP)

  • Any change in MPP is attributed to the hiring of one additional employee.

Gottheil - Principles of Economics, 4e

slide7

EXHIBIT 1A OUTPUT AND MARGINAL PHYSICAL PRODUCT CURVES

Gottheil - Principles of Economics, 4e

slide8

EXHIBIT 1B OUTPUT AND MARGINAL PHYSICAL PRODUCT CURVES

Gottheil - Principles of Economics, 4e

exhibit 1 output and marginal physical product curves
Exhibit 1: Output and Marginal Physical Product Curves

1. How can the shape of the total output curve in panel a of Exhibit 1 be described?

  • The total output curve is upward sloping, increasing by large amounts until three miners are employed, then increasing by smaller and smaller amounts when more than three miners are employed.

Gottheil - Principles of Economics, 4e

exhibit 1 output and marginal physical product curves10
Exhibit 1: Output and Marginal Physical Product Curves

2. Why does the MPP curve in panel b climb to a peak and then fall?

  • The MPP curve maps the increases noted in the total output curve. The MPP increases for the first three miners, then falls as more miners are added to production.

Gottheil - Principles of Economics, 4e

you load sixteen tons and what do you get11
You Load Sixteen Tons and What Do You Get?

Law of diminishing returns

  • As more and more units of one factor of production are added to the production process while other factors remain unchanged, output will increase, but by smaller and smaller increments.

Gottheil - Principles of Economics, 4e

you load sixteen tons and what do you get12
You Load Sixteen Tons and What Do You Get?

Law of diminishing returns

  • Adding more labor to a given stock of physical capital must eventually create a less-than-efficient match of labor to capital.

Gottheil - Principles of Economics, 4e

you load sixteen tons and what do you get13
You Load Sixteen Tons and What Do You Get?

Law of diminishing returns

  • The law is demonstrated in the eventual flattening of the total output curve and the negative slope of the MPP curve.

Gottheil - Principles of Economics, 4e

you load sixteen tons and what do you get14
You Load Sixteen Tons and What Do You Get?

Marginal revenue product (MRP)

  • The change in total revenue that results from adding one more unit of a resource, such as labor, to production. MRP, which is expressed in dollars, is equal to MPP multiplied by the price of the good.

Gottheil - Principles of Economics, 4e

you load sixteen tons and what do you get15
You Load Sixteen Tons and What Do You Get?

Marginal revenue product

  • MRP = MPP × price
    • or
  • MRP = change in total revenue (TR) divided by change in labor (L).

Gottheil - Principles of Economics, 4e

deriving the firm s demand for labor
Deriving the Firm’s Demand for Labor

The quantity of labor demanded depends on price. If the price of labor falls, the quantity demanded of labor increases.

Gottheil - Principles of Economics, 4e

deriving the firm s demand for labor17
Deriving the Firm’s Demand for Labor

Wage rate

  • The price of labor. Typically, the wage rate is calculated in dollars per hour.

Gottheil - Principles of Economics, 4e

deriving the firm s demand for labor18
Deriving the Firm’s Demand for Labor

Total labor cost (TLC)

  • Quantity of labor employed (L) multiplied by the wage rate (W).
  • TLC = L × W

Gottheil - Principles of Economics, 4e

deriving the firm s demand for labor19
Deriving the Firm’s Demand for Labor

Marginal labor cost (MLC)

  • The change in a firm’s total cost that results from adding one more worker to production.

Gottheil - Principles of Economics, 4e

deriving the firm s demand for labor20
Deriving the Firm’s Demand for Labor

Marginal labor cost (MLC)

  • MLC = change in TLC divided by change in L.

Gottheil - Principles of Economics, 4e

slide21

EXHIBIT 2A DERIVING THE MARGINAL LABOR COST CURVE

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slide22

EXHIBIT 2B DERIVING THE MARGINAL LABOR COST CURVE

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exhibit 2 deriving the marginal labor cost curve
Exhibit 2: Deriving the Marginal Labor Cost Curve

What causes the MLC curve to be horizontal in panel b of Exhibit 2?

  • The labor market is perfectly competitive. Individual firms cannot influence the wage rate. The firm can hire as many workers as it wants at the prevailing wage rate. MLCis equal to the wage rate.

Gottheil - Principles of Economics, 4e

deriving the firm s demand for labor24
Deriving the Firm’s Demand for Labor

The hiring rule for firms:

  • Compare marginal revenue product and wage rate and hire laborers until MRP = W.
  • If MRP > W, hire more laborers.
  • If MRP < W, don’t hire.

Gottheil - Principles of Economics, 4e

slide25

EXHIBIT 3 THE DEMAND FOR LABOR

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exhibit 3 the demand for labor
Exhibit 3: The Demand for Labor

Why is a firm’s demand for labor equal to marginal revenue product (MRP)?

  • MRP reflects the maximum a firm is willing to pay for an additional unit of labor.

Gottheil - Principles of Economics, 4e

exhibit 3 the demand for labor27
Exhibit 3: The Demand for Labor

Why is a firm’s demand for labor equal to marginal revenue product (MRP)?

  • When the price of labor falls, firms can afford to hire more labor, even though MRP declines.

Gottheil - Principles of Economics, 4e

deriving the firm s demand for labor28
Deriving the Firm’s Demand for Labor

Changes in the price of a good and improvements in technology shift the demand curve for labor to the right.

Gottheil - Principles of Economics, 4e

slide29

EXHIBIT 4 SHIFT IN THEA DEMAND CURVE FOR LABOR CAUSED BY AN INCREASE IN THE PRICE OF THE GOOD

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exhibit 4 shift in the demand curve for labor caused by an increase in the price of the good
Exhibit 4: Shift in the Demand Curve for Labor Caused by an Increase in the Price of the Good

How does an increase in the price of coal affect the number of miners hired at a wage rate of $24?

  • When the price of coal is $2, seven miners are hired at a wage rate of $24.

Gottheil - Principles of Economics, 4e

exhibit 4 shift in the demand curve for labor caused by an increase in the price of the good31
Exhibit 4: Shift in the Demand Curve for Labor Caused by an Increase in the Price of the Good

How does an increase in the price of coal affect the number of miners hired at a wage rate of $24?

  • When the price of coal increases to $3, the demand curve for miners shifts to the right.

Gottheil - Principles of Economics, 4e

exhibit 4 shift in the demand curve for labor caused by an increase in the price of the good32
Exhibit 4: Shift in the Demand Curve for Labor Caused by an Increase in the Price of the Good

How does an increase in the price of coal affect the number of miners hired at a wage rate of $24?

  • At the new coal price, nine miners are demanded at the wage rate of $24.

Gottheil - Principles of Economics, 4e

slide33

EXHIBIT 5 THE DERIVATION OF MRP USING OLD AND NEW TECHNOLOGY (PRICE OF COAL = $2)

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exhibit 5 the derivation of mrp using old and new technology price of coal 2
Exhibit 5: The Derivation of MRP Using Old and New Technology (Price of Coal = $2)

How does a change from old technology to new technology affect the MPP and MRP in Exhibit 5?

  • With new technology the same miner is able to produce twice as much coal.

Gottheil - Principles of Economics, 4e

exhibit 5 the derivation of mrp using old and new technology price of coal 235
Exhibit 5: The Derivation of MRP Using Old and New Technology (Price of Coal = $2)

How does a change from old technology to new technology affect the MPP and MRP in Exhibit 5?

  • The new technology doubles both MPP and MRP.

Gottheil - Principles of Economics, 4e

industry demand for labor
Industry Demand for Labor

If all of the firms in an industry have essentially the same quality resources, use the same technology, and compete for the same laborers in the same labor market, then the industry’s demand curve for labor is the same as the individual firm’s demand curve for labor, magnified by the number of firms in the industry.

Gottheil - Principles of Economics, 4e

slide37

EXHIBIT 6 INDUSTRY DEMAND FOR LABOR

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exhibit 6 industry demand for labor
Exhibit 6: Industry Demand for Labor

What is the firm’s demand for labor at a wage rate of $20 compared to the industry’s demand for labor at the same wage rate?

  • The firm’s demand for labor is 8 at a wage rate of $20.

Gottheil - Principles of Economics, 4e

exhibit 6 industry demand for labor39
Exhibit 6: Industry Demand for Labor

What is the firm’s demand for labor at a wage rate of $20 compared to the industry’s demand for labor at the same wage rate?

  • With 1,000 firms in the industry, the industry’s demand for labor at $20 = (8 × 1,000) = 8,000 laborers.

Gottheil - Principles of Economics, 4e

the supply of labor
The Supply of Labor

The opportunity cost of working —the value a laborer places on the next best alternative to working—is different for different people.

Gottheil - Principles of Economics, 4e

the supply of labor41
The Supply of Labor

Opportunity cost determines how many people are willing to work at differing wage rates.

Gottheil - Principles of Economics, 4e

slide42

EXHIBIT 7 THE SUPPLY CURVE OF LABOR

Gottheil - Principles of Economics, 4e

exhibit 7 the supply curve of labor
Exhibit 7: The Supply Curve of Labor

Why does the labor supply curve slope up in Exhibit 7?

  • The curve is upward sloping because the higher the wage rate, the more willing are workers to supply greater quantities of labor. Their opportunity costs are met at higher wage rates.

Gottheil - Principles of Economics, 4e

the supply of labor44
The Supply of Labor

Three factors affect workers’ willingness to supply their labor at different wage rates: changes in alternative employment opportunities, changes in population size, and changes in wealth.

Gottheil - Principles of Economics, 4e

the supply of labor changes in alternative employment opportunities
The Supply of Labor: Changes in Alternative Employment Opportunities
  • When new industries willing to pay higher wage rates enter a market, fewer laborers are willing to work for the older industry at the lower wage rate.
  • The supply curve for labor in the older industry shifts to the left.

Gottheil - Principles of Economics, 4e

the supply of labor changes in population size
The Supply of Labor: Changes in Population Size
  • When the population of a region declines, the number of workers willing to work at any wage rate declines.
  • The supply curve for labor shifts to the left.

Gottheil - Principles of Economics, 4e

the supply of labor changes in wealth
The Supply of Labor: Changes in Wealth
  • When people have more wealth, they choose more leisure time and less work.
  • The supply curve for labor shifts to the left.

Gottheil - Principles of Economics, 4e

slide48

EXHIBIT 8 CHANGES IN THE SUPPLY CURVE OF LABOR

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exhibit 8 changes in the supply curve of labor
Exhibit 8: Changes in the Supply Curve of Labor

What happens to the quantity of labor supplied at a wage rate of $20 when the supply curve shifts from S to S1?

  • The quantity of labor supplied drops from 8,000 to 6,000.

Gottheil - Principles of Economics, 4e

the supply of labor50
The Supply of Labor

An increase in the wage rate typically induces workers to increase the quantity of labor supplied, but only up to a certain point.

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the supply of labor51
The Supply of Labor

After that point, an increase in the wage rate results in less, not more, labor supplied.

Gottheil - Principles of Economics, 4e

exhibit 9 the backward bending supply curve of labor
Exhibit 9: The Backward-Bending Supply Curve of Labor

What is the wage rate at which the laborer in Exhibit 9 decides to cut back on the quantity of labor he is willing to supply?

  • The laborer is willing to increase the quantity of labor supplied up to a wage rate of $40.

Gottheil - Principles of Economics, 4e

exhibit 9 the backward bending supply curve of labor54
Exhibit 9: The Backward-Bending Supply Curve of Labor

What is the wage rate at which the laborer in Exhibit 9 decides to cut back on the quantity of labor he is willing to supply?

  • Above $40, the laborer cuts back on hours worked per week and gains more leisure time.

Gottheil - Principles of Economics, 4e

exhibit 9 the backward bending supply curve of labor55
Exhibit 9: The Backward-Bending Supply Curve of Labor

What is the wage rate at which the laborer in Exhibit 9 decides to cut back on the quantity of labor he is willing to supply?

  • To the laborer, the value of the leisure time is greater than the extra income he could have earned by working more hours.

Gottheil - Principles of Economics, 4e

deriving equilibrium wage rates
Deriving Equilibrium Wage Rates

Combining the industry demand curve for labor and the industry supply curve for labor allows the industry equilibrium wage rate to be derived.

Gottheil - Principles of Economics, 4e

deriving equilibrium wage rates57
Deriving Equilibrium Wage Rates
  • Individual firms within the industry have no influence on the market wage rate.
  • Firms must accept the market wage rate and face a horizontal supply curve for labor.

Gottheil - Principles of Economics, 4e

slide58

EXHIBIT 10 THE LABOR MARKET

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exhibit 10 the labor market
Exhibit 10: The Labor Market

How is the level of the horizontal labor supply curve for the firm in panel b of Exhibit 10 determined?

  • The level of the labor supply curve is equal to the equilibrium wage rate of the industry (W = $20).

Gottheil - Principles of Economics, 4e

explaining wage rate differentials
Explaining Wage Rate Differentials

How different opportunity costs of laborers affect the supply curve of labor and how differences in technology and the price of goods produced by labor affect MRP help explain why different wage rates exist in different labor markets.

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slide61

EXHIBIT 11 NORTH-SOUTH WAGE RATE DIFFERENTIALS

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exhibit 11 north south wage rate differentials
Exhibit 11: North-South Wage Rate Differentials

What are the factors that caused the wage rate to decline in the North in Exhibit 11?

  • Immigration from the South to the North increased the pool of laborers and thus shifted the North’s labor supply curve to the right.

Gottheil - Principles of Economics, 4e

exhibit 11 north south wage rate differentials63
Exhibit 11: North-South Wage Rate Differentials

What are the factors that caused the wage rate to decline in the North in Exhibit 11?

  • At the same time, relocation of factories from the North to the South shifted the North’s demand curve for labor to the left.

Gottheil - Principles of Economics, 4e

exhibit 11 north south wage rate differentials64
Exhibit 11: North-South Wage Rate Differentials

What are the factors that caused the wage rate to decline in the North in Exhibit 11?

  • An increase in the supply of labor and a decrease in the demand for labor caused the wage rate to decline in the North.

Gottheil - Principles of Economics, 4e

slide65

Source: Bureau of the Census, Statistical Abstract of the United States, 2001 (Washington, D.C.: U.S. Department of Commerce, 2001), p. 28.

EXHIBIT 12 NET DOMESTIC MIGRATION AND IMMIGRATION FOR THE NORTHEAST, MIDWEST, SOUTH, AND WEST: 1998–99 (1,000s OF POPULATION)

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exhibit 12 net domestic migration and immigration for the northeast midwest south and west 1998 99
Exhibit 12: Net Domestic Migration and Immigration for the Northeast, Midwest, South, and West: 1998-99

Based on Exhibit 12, which region of the country experienced the greatest net total migration?

  • The South experienced the greatest net total migration, with the West a distant second.

Gottheil - Principles of Economics, 4e

explaining wage rate differentials67
Explaining Wage Rate Differentials

The supply curve of labor is affected not only by the supply conditions in the labor market, but also by the government’s immigration policy.

Gottheil - Principles of Economics, 4e

persisting wage differentials
Persisting Wage Differentials

Noncompeting labor markets

  • Markets whose requirement for specific skills necessarily excludes workers who do not have the required skills.

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persisting wage differentials69
Persisting Wage Differentials

Specific talents, limited to small numbers of people, create unique labor markets that allow relatively high wage rates and protect wage rates against erosion.

Gottheil - Principles of Economics, 4e

the economics of minimum wage rates
The Economics of Minimum Wage Rates

The problem with persistent wage differentials is not so much that a few people make millions, but that some people are unable to compete successfully in any occupation that provides an adequate standard of living.

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the economics of minimum wage rates71
The Economics of Minimum Wage Rates

In an effort to remedy the problem, government can outlaw low wage rates by implementing a minimum wage law.

Gottheil - Principles of Economics, 4e

the economics of minimum wage rates72
The Economics of Minimum Wage Rates
  • The problem with mandated minimum wage rates is that employers cannot be expected to hire workers whose MRP is below the legislated minimum wage rate.
  • Thus some workers are left with no job at all.

Gottheil - Principles of Economics, 4e

the economics of minimum wage rates73
The Economics of Minimum Wage Rates

The impact of minimum-wage legislation on low-wage-rate-earning people depends on the price elasticities of demand and supply for labor.

Gottheil - Principles of Economics, 4e

slide74

EXHIBIT 13 THE EFFECTS OF MINIMUM WAGE RATES

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exhibit 13 the effects of minimum wage rates
Exhibit 13: The Effects of Minimum Wage Rates

1. How many people lose their job when minimum wage rates are implemented under the price elasticities of supply and demand for labor in panel a?

  • 1,000 workers were employed at $3 per hour.

Gottheil - Principles of Economics, 4e

exhibit 13 the effects of minimum wage rates76
Exhibit 13: The Effects of Minimum Wage Rates

1. How many people lose their job when minimum wage rates are implemented under the price elasticities of supply and demand for labor in panel a?

  • Only 300 workers are employed at $5.15. Thus 700 workers lose their jobs.

Gottheil - Principles of Economics, 4e

exhibit 13 the effects of minimum wage rates77
Exhibit 13: The Effects of Minimum Wage Rates

2. How many people lose their job when minimum wage rates are implemented under the price elasticities of supply and demand for labor in panel b?

  • 1,000 laborers were employed at $3 per hour.

Gottheil - Principles of Economics, 4e

exhibit 13 the effects of minimum wage rates78
Exhibit 13: The Effects of Minimum Wage Rates

2. How many people lose their job when minimum wage rates are implemented under the price elasticities of supply and demand for labor in panel b?

  • 9,000 laborers are employed at $5.15 per hour. Thus only 100 lose their job.

Gottheil - Principles of Economics, 4e

the ethics of w mrp
The Ethics of w = MRP
  • Most economists accept market-determined wage rates as ethically defensible.
  • The ethic is expressed as “From each according to his or her contribution, to each according to his or her contribution.”

Gottheil - Principles of Economics, 4e

the efficiency wages theory
The Efficiency Wages Theory

Efficiency wages

  • A wage higher than the market’s equilibrium rate; a firm will pay this wage in the expectation that the higher wage will reduce the firm’s labor turnover and increase labor productivity.

Gottheil - Principles of Economics, 4e

the efficiency wages theory81
The Efficiency Wages Theory

There are several reasons why a firm may choose to pay efficiency wages:

  • Efficiency wages increase workers’ morale and motivation on the job.
  • Efficiency wages allow the firm to select more qualified workers.

Gottheil - Principles of Economics, 4e

the efficiency wages theory82
The Efficiency Wages Theory

There are several reasons why a firm may choose to pay efficiency wages:

  • Reduce labor turnover.
  • Deter workers from joining unions.
  • Fairness—if the firm is making a profit, it should share some with its workforce.

Gottheil - Principles of Economics, 4e