Chapter 15 WAGE RATES IN COMPETITIVE LABOR MARKETS Gottheil — Principles of Economics, 7e © 2013 Cengage Learning 1

Chapter 15Chapter 15

WAGE RATES IN WAGE RATES IN COMPETITIVE LABOR COMPETITIVE LABOR MARKETSMARKETS

Gottheil — Principles of Economics, 7e© 2013 Cengage Learning1

Economic PrinciplesEconomic Principles

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e2

Marginal physical product of labor

Marginal revenue product

The law of diminishing returns

Marginal labor cost

The profit-maximizing level of employment

Economic PrinciplesEconomic Principles


Firm and industry demand for labor

The supply of labor

The backward-bending supply curve of labor

Wage differentials

Minimum wage laws

You Load Sixteen Tons and You Load Sixteen Tons and What Do You Get?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.




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




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


EXHIBIT 1A OUTPUT AND MARGINAL PHYSICAL PRODUCT CURVES


EXHIBIT 1B OUTPUT AND MARGINAL PHYSICAL PRODUCT CURVES

Exhibit 1: Output and Marginal Exhibit 1: Output and Marginal Physical Product CurvesPhysical 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.

Exhibit 1: Output and Marginal Exhibit 1: Output and Marginal Physical Product CurvesPhysical 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.



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.




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




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



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.



Marginal revenue product

• MRP = MPP × price

or

• MRP = change in total revenue (TR) divided by change in labor (L)

Deriving the Firm’s Demand Deriving the Firm’s Demand for Laborfor Labor


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



Wage rate

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



Total labor cost (TLC)

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

• TLC = L × W



Marginal labor cost (MLC)

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



Marginal labor cost (MLC)

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


EXHIBIT 2A DERIVING THE MARGINAL LABOR COST CURVE


EXHIBIT 2B DERIVING THE MARGINAL LABOR COST CURVE

Exhibit 2: Deriving the Marginal Exhibit 2: Deriving the Marginal Labor Cost CurveLabor 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. MLC is equal to the wage rate.

Deriving the Firm’s Demand for Deriving the Firm’s Demand for LaborLabor


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.


EXHIBIT 3 THE DEMAND FOR LABOR

Exhibit 3: The Demand for LaborExhibit 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.

Exhibit 3: The Demand for LaborExhibit 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.



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


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

Exhibit 4: Shift in the Demand Curve Exhibit 4: Shift in the Demand Curve for Labor Caused by an Increase in for Labor Caused by an Increase in

the Price of the Goodthe 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.




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.




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.


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

Exhibit 5: The Derivation of Exhibit 5: The Derivation of MRPMRP Using Old and New Technology Using Old and New Technology

(Price of Coal = $2)(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.

Exhibit 5: The Derivation of Exhibit 5: The Derivation of MRPMRP Using Old and New Technology Using Old and New Technology

(Price of Coal = $2)(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.

Industry Demand for LaborIndustry 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.


EXHIBIT 6 INDUSTRY DEMAND FOR LABOR

Exhibit 6: Industry Demand Exhibit 6: Industry Demand for Laborfor 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.

Exhibit 6: Industry Demand Exhibit 6: Industry Demand for Laborfor 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.

The Supply of LaborThe 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.



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


EXHIBIT 7 THE SUPPLY CURVE OF LABOR

Exhibit 7: The Supply Curve Exhibit 7: The Supply Curve of Laborof 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.



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.

The Supply of Labor: Changes The Supply of Labor: Changes in Alternative Employment in Alternative Employment

OpportunitiesOpportunities


• 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.

The Supply of Labor: Changes The Supply of Labor: Changes in Population Sizein 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.

The Supply of Labor: Changes The Supply of Labor: Changes in Wealthin Wealth


• When people have more wealth, they choose more leisure time and less work.

• The supply curve for labor shifts to the left.


EXHIBIT 8 CHANGES IN THE SUPPLY CURVE OF LABOR

Exhibit 8: Changes in the Exhibit 8: Changes in the Supply Curve of LaborSupply 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.



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



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


EXHIBIT 9 THE BACKWARD-BENDING SUPPLY CURVE OF LABOR

Exhibit 9: The Backward-Exhibit 9: The Backward-Bending Supply Curve of LaborBending 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.



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.



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.

Deriving Equilibrium Deriving Equilibrium Wage RatesWage Rates


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

Deriving Equilibrium Deriving Equilibrium Wage RatesWage 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.


EXHIBIT 10 THE LABOR MARKET

Exhibit 10: The Labor MarketExhibit 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).

Explaining Wage Rate DifferentialsExplaining 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.


EXHIBIT 11 U.S.- MEXICO WAGE RATE DIFFERENTIALS

Exhibit 11: Exhibit 11: U.S.- Mexico Wage U.S.- Mexico Wage Rate DifferentialsRate Differentials


What are the factors that caused the wage rate to decline in Texas in Exhibit 11?• Immigration from Chihuahua to Texas

increased the pool of laborers and thus shifted Texas’ labor supply curve to the right.



What are the factors that caused the wage rate to decline in Texas in Exhibit 11?• At the same time, relocation of factories from

Texas to the Chihuahua shifted Texas’ demand curve for labor to the left.



What are the factors that caused the wage rate to decline in Texas 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 Texas.


EXHIBIT 12 MEXICAN FOREIGN BORN POPULATIONS IN THE UNITED STATES: LEGAL 1960–2006

POPULATION)

Source: U.S. Census Bureau, Working Paper No. 29, Historical Census Statistics on the Foreign-Born Population of the United States: 1850–1900, US Government Printing Office, Washington, DC, 1999. Data for 2000 and 2006 are from US Bureau’s Census 2000 and American Community Survey 2006.

Exhibit 12: Exhibit 12: Mexican Foreign Born Mexican Foreign Born Populations in the United States:Populations in the United States:

Legal 1960–2006Legal 1960–2006


Mexican immigration (legal) more than doubled during the 1990s and continued to increase into the twenty-first century

Explaining Wage Rate Explaining Wage Rate DifferentialsDifferentials


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.


EXHIBIT 13 MEDIAN HOURLY PAY FOR SELECT EU COUNTRIES: PRIVATE SECTOR

(AS PERCENT OF HOURLY PAY IN DENMARK)

Source: FedEE Pay in Europe 2006 Report, shown in http://www.finfacts.com/Private/isl/PayinEurope.htm

Exhibit 13: Median Hourly Pay for Exhibit 13: Median Hourly Pay for Select EU Countries: Private Select EU Countries: Private

SectorSector


Substantial migrant flows from East Europe to West Europe because of:

•Basic EU policy of free movement of population within the EU

•Considerable East-West wage differentials within the EU


EXHIBIT 14 MIGRANT POPULATIONS AND PERCENT OF TOTAL WORLD POPULATION: 2005 (THOUSANDS AND PERCENT)

Source: International Migration, 2006, United Nations, Department of Economic and Social Affairs, Population Division, 2006

Exhibit 14: Migrant Populations Exhibit 14: Migrant Populations and Percent of Total World and Percent of Total World

Population: 2005Population: 2005


In 2005, an estimated 191 million people representing three percent of the world’s population lived outside their country of birth.

Exhibit 14: Migrant Populations Exhibit 14: Migrant Populations and Percent of Total World and Percent of Total World

Population: 2005Population: 2005


1.4 percent of the total population in the less developed countries migrated in 2005.

Persisting Wage DifferentialsPersisting Wage Differentials


Noncompeting labor markets

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

Persisting Wage DifferentialsPersisting 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.

The Economics of The Economics of Minimum Wage RatesMinimum 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.



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



• 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.



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


EXHIBIT 15 THE EFFECTS OF MINIMUM WAGE RATES

Exhibit 15: The Effects of Exhibit 15: The Effects of Minimum Wage RatesMinimum 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.



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.



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.



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.

The Ethics of The Ethics of ww = = MRPMRP


• 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.”

The Efficiency Wages TheoryThe 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.



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.



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.

The Principal-Agent ProblemThe Principal-Agent Problem


Principal-agent problem

• A problem that arises when either demander or supplier in a labor market exercises an undisclosed personal interest or motive that undermines the efficacy of the market.

Documents

Chapter 15 WAGE RATES IN COMPETITIVE LABOR MARKETS Gottheil — Principles of Economics, 7e © 2013 Cengage Learning 1