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The Market for Labor: Time Allocation and Equilibrium

Explore how individual decisions about time allocation impact labor supply, and learn how the labor market reaches equilibrium. Discover the factors that shift the labor supply curve and explore the effects of imperfect competition.

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The Market for Labor: Time Allocation and Equilibrium

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  1. MODULE 35 (71)The Market for Labor

  2. The way in which a worker’s decision about time allocation gives rise to labor supply • How to find equilibrium in the labor market

  3. The Supply of Labor • Decisions about labor supply result from decisions about time allocation:how many hours to spend on different activities. • Leisure is time available for purposes other than earning money to buy marketed goods. • How does a rational individual decide how much leisure to consume? • Time allocation changes when the wage rate changes.

  4. The Supply of Labor • A rise in the wage rate causes both an income and a substitution effect on an individual’s labor supply. • The substitution effect of a higher wage rate induces longer work hours, other things equal. • This is countered by the income effect: higher income leads to a higher demand for leisure, a normal good. • If the income effect dominates, a rise in the wage rate can actually cause the individual labor supply curve to slope the “wrong” way or downward.

  5. The Supply of Labor • In the following graph, the individual labor supply curve shows how the quantity of labor supplied by an individual depends on that individual’s wage rate.

  6. The Individual Labor Supply Curve (a) The Substitution Effect Dominates (b) The Income Effect Dominates Wage rate Wage rate Individual labor supply curve $20 $20 10 10 Individual labor supply curve 0 40 50 0 30 40 Quantity of labor (hours) Quantity of labor (hours)

  7. Shifts of the Labor Supply Curve • The market labor supply curve is the horizontal sum of the individual supply curves of all workers in that market. • It shifts for four main reasons: • changes in preferences and social norms • changes in population • changes in opportunities • changes in wealth

  8. The Decline of the Summer Job • In recent years, a growing number of young Americans have chosen not to take summer jobs. • An important factor is increasing household affluence, which has resulted in many teenagers no longer feeling the pressure to contribute to household finances. • The income effect has led to a reduced labor supply. • Another factor points to the substitution effect: increased competition from immigrants. • This has led to a decline in wages, so teenagers forgo summer work and consume leisure instead.

  9. Equilibrium in the Labor Market • The equilibrium wage is the wage rate at which the quantity of labor supplied is equal to the quantity of labor demanded.

  10. Equilibrium in the Labor Market Wage Market labor supply curve Equilibrium value of the marginal product of labor E W* Market labor demand curve L* Quantity of labor (workers) Equilibrium employment

  11. When the Product Market is Not Perfectly Competitive • When the product market is perfectly competitive, the wage rate is equal to the value of the marginal product of labor at equilibrium.

  12. When the Product Market is Not Perfectly Competitive • If the market is not perfectly competitive, there is a price effect, so that the price of the output must go down to increase output sold. • To determine the demand for workers in this situation, the monopolist must multiply the marginal product of labor by the marginal revenue to get the marginal revenue product of labor or MRPL.

  13. When the Product Market Is Not Perfectly Competitive Marginal Revenue Product of Labor with Imperfect Competition in the Product Market

  14. When the Product Market Is Not Perfectly Competitive

  15. When the Labor Market is Not Perfectly Competitive • The marginal factor cost of labor (MFCL), is the additional cost of hiring one more unit of labor. • When the labor market is imperfectly competitive, firms use MFCL to determine how much to hire. • For a monopsony, MFCL increases as the number of labors increases.

  16. Firm Labor Supply in a Perfectly Competitive labor Market

  17. When the Labor Market is Not Perfectly Competitive

  18. Supply of Labor and Marginal Factor Cost in an Imperfectly Competitive Market

  19. Equilibrium in the Imperfectly Competitive Labor Market • Firms should hire workers until: MRPL = MFCL

  20. Equilibrium in the Labor Market with Imperfect Competition

  21. Labor supply is the result of decisions about timeallocation,where each worker faces a trade-off betweenleisure and work. • An increase in the hourly wage ratetends to increase work hours via the substitution effectbut to reduce work hours via the income effect. If the netresult is that a worker increases the quantity of laborsupplied in response to a higher wage, the individuallabor supply curve slopes upward. • The market labor supply curve is the horizontal sum of theindividual labor supply curves of all workers in that market.It shifts for four main reasons: changes in preferencesand social norms, changes in population, changes inopportunities, and changes in wealth.

  22. Equilibrium in the labor market happens when the quantity of labor supplied equals the quantity of labor demanded. • When the product market is not perfectly competitive, the imperfectly competitive firm used MRPL to determine the quantity of labor to hire. • When the labor market is not perfectly competitive, the firm uses the MFCL, which is higher than the wage, to determine the quantity of labor to hire. • The rule for hiring is MRPL = MFCL.

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