Lecture 11

Markets for Labor

How can we explain wage differences?

• Oprah Winfrey has made $260 million per year• An aerospace engineer in the U.S. receives $89,000

on average per year• A preschool teacher receives $26,000 on average

per year• What causes these differences? Can we explain

them with differences in productivity?

Labor productivity

• Demand for labor is related to the productivity of the labor

• Main contributors to variations in labor productivity:– The skills of the workers– The efficiency with which workers apply their skills– The level of effort with which workers work– The quantity and the characteristics of the resources

available to each worker

Labor supply

• What is the opportunity cost of paid employment?

The opportunity cost of engaging in paid work is the highest value of the time that might otherwise have been spent in alternative uses such as:– Household production– Education– Self-employment– Leisure

Labor supply

• What is the benefit of paid employment?– Wages and salaries (extrinsic motivations)– Work experience itself (intrinsic motivation)

• Labor force participation:The percentage of the adult population who are either

working at a paid job or seeking paid work

Individual labor supply• Assumptions:

– The worker can find a job that meets his/her desires

– There is only one kind of paid job– The job has no intrinsic motivation

Quantity of Labor

Wa

ge

(pr

ice

of

lab

or

$)

Supply of Labor

Individual labor supply

Quantity of Labor

Wa

ge

(pr

ice

of

lab

or

$)

Supply of Labor

Quantity of LaborW

ag

e (

pric

e o

f la

bo

r$

)

Supply of Labor

Substitution effectis stronger

Income effectis stronger

An upward-sloping individual supply curve for labor

A backward-bending individual supply curve for labor

Market labor supply

Quantity of Labor

Wa

ge

(pr

ice

of

lab

or

$)

Supply of Labor

Market labor demand

• Demand curve for labor is downward-sloping:

– When wages are high, employers have incentives to economize on the use of labor

– When wages are low, employers may be able to expand their productive activities or substitute relatively cheap labor for other inputs

Labor market adjustment

Quantity of Labor

Q2

W2

W1

Q1

Wa

ge

($

)S

D1

E1

E2

Labor in traditional neoclassical model

Labor in traditional neoclassical model

• Example: A firm producing disposable razors

Labor in traditional neoclassical modelQ

ua

ntit

y o

f R

azo

rs

0

5

10

15

20

25

30

35

987654321

Quantity of Labor (number of workers)

Total Product Curve

Labor in traditional neoclassical modelC

ost

an

d R

even

ue

($

)

0

3

6

9

12

15

18

24

21

987654321

Quantity of Labor (number of workers)

MFCL

MRPL

Explaining variations in wages• Market forces and observable productivity differences are

only part of the explanation of variation in wages.

• Other potential sources for variation: – Human capital– Market power (See the case for monopsony!)– Compensating wage differentials– Worker motivation

• Efficiency wages• Employee morale• Dual labor markets

– Discrimination