14.1The Theory of Labor Markets
than the more than $25,000 estimated as the average cost in 2022 for a year of college at a public university. The result of these costs is that student loan debt topped $1.3 trillion this year. Despite these disheartening figures, the value of a bachelor’s degree has never been higher. How do we explain this? This chapter will tell us. In a like the United States, comes from ownership of the means of : resources or assets. More precisely, one’s is a function of two things: the quantity of each resource one owns, and the value society places on those resources. Recall from the chapter on , Costs, and Industry , each factor of has an associated factor payment. For the majority of us, the most important resource we own is our labor. Thus, most of our is wages, salaries, commissions, tips and other types of labor . Your labor depends on how many hours you work and the wage rate an employer will pay you for those hours. At the same time, some people own real estate, which they can either use themselves or rent out to other users. Some people have financial assets like bank accounts, stocks and bonds, for which they earn interest, dividends or some other form of . Each of these factor payments, like wages for labor and interest for , is determined in their respective factor markets. For the rest of this chapter, we will focus on labor markets, but other factor markets operate similarly. Later in Chapter 17 we will describe how this works for financial capital.
14.1 The Theory of Labor Markets
LEARNING OBJECTIVES By the end of this section, you will be able to:
- Describe the for labor in perfectly competitive output markets
- Describe the for labor in output markets
- Identify what determines the going rate for labor
CLEAR IT UP What is the ? The is the term that economists use for all the different markets for labor. There is no single . Rather, there is a different for every different type of labor. Labor differs by type of work (e.g. retail sales vs. scientist), skill level ( level or more experienced), and location (the for administrative assistants is probably more local or regional than the for university presidents). While each is different, they all tend to operate in similar ways. For example, when wages go up in one , they tend to go up in others too. When economists talk about the , they are describing these similarities. The , like all markets, has a and a supply. Why do firms demand labor? Why is an employer willing to pay you for your labor? It’s not because the employer likes you or is socially conscious. Rather, it’s because your labor is worth something to the employer--your work brings in revenues to the firm. How much is an employer willing to pay? That depends on the skills and experience you bring to the firm. If a firm wants to maximize profits, it will never pay more (in terms of wages and benefits) for a worker than the value of their marginal productivity to the firm. We call this the first rule of labor markets. Suppose a worker can produce two widgets per hour and the firm can sell each widget for $4 each. Then the worker is generating $8 per hour in revenues to the firm, and a profit-maximizing employer will pay the worker up to, but no more than, $8 per hour, because that is what the worker is worth to the firm. Recall the definition of marginal product. Marginal product is the additional output a firm can produce by adding one more worker to the production process. Since employers often hire labor by the hour, we’ll define marginal product as the additional output the firm produces by adding one more worker hour to the production process. In this chapter, we assume that workers in a particular labor market are homogeneous—they have the same background, experience and skills and they put in the same amount of effort. Thus, marginal product depends on the capital and technology with which workers have to work. A typist can type more pages per hour with an electric typewriter than a manual typewriter, and the typist can type even more pages per hour with a personal computer and word processing software. A ditch digger can dig more cubic feet of dirt in an hour with a backhoe than with a shovel. Thus, we can define the demand for labor as the marginal product of labor times the value of that output to the firm. # Workers (L) 1 2 3 4 MPL 4 3 2 1 TABLE 14.1Marginal Product of Labor
FIGURE 14.2Marginal Product of LaborBecause of fixed capital, the of labor declines as the employer hires additional workers. On what does the value of each worker’s depend? If we assume that the employer sells its output in a perfectly competitive , the value of each worker’s output will be the of the product. Thus, for Labor = MPL x P = Value of the of Labor We show this in , which is an expanded version of # Workers (L) 1 2 3 4 MPL 4 3 2 1 of Output $4 $4 $4 $4 VMPL $16 $12 $8 $4 TABLE 14.2Value of the of Labor Note that the value of each additional worker is less than the value of the ones who came before.
FIGURE 14.3Value of the of LaborFor firms operating in a competitive output , the value of additional output sold is the the firms receive for the output. Since MPL declines with additional labor employed, while that is worth the , the value of the declines as employment increases.
Demand for Labor in Perfectly Competitive Output Markets
The question for any is how much labor to hire. We can define a as one where firms can hire all the labor they want at the going wage. Think about secretaries in a large city. Employers who need secretaries can probably hire as many as they need if they pay the going wage rate. Graphically, this means that firms face a horizontal supply curve for labor, as shows. Given the wage, profit maximizing firms hire workers up to the point where: Wmkt = VMPL
FIGURE 14.4Equilibrium Employment for Firms in a Competitive Labor MarketIn a , firms can hire all the labor they want at the going wage. Therefore, they hire workers up to the point L1 where the going wage equals the value of the of labor. CLEAR IT UP Derived Economists describe the for like labor as a derived . Since the for labor is MPL*P, it is dependent on the for the product the is producing. We show this by the P term in the for labor. An increase in demand for the firm’s product drives up the product’s price, which increases the firm’s demand for labor. Thus, we derive the demand for labor from the demand for the firm’s output.
Demand for Labor in Imperfectly Competitive Output Markets
If the employer does not sell its output in a perfectly competitive industry, they face a downward sloping for output, which means that in order to sell additional output the must lower its . This is true if the is a , but it’s also true if the is an or monopolistically competitive. In this situation, the value of a worker’s is the , not the . Thus, the for labor is the times the marginal revenue. The Demand for Labor = MPL x MR = Marginal Revenue Product # Workers (L) 1 2 3 4 MPL 4 3 2 1 Marginal Revenue $4 $3 $2 $1 MRPL $16 $9 $4 $1 TABLE 14.3Marginal Revenue Product
FIGURE 14.5Marginal ProductFor firms with some power in their output , the value of additional output sold is the ’s . Since MPL declines with additional labor employed and since MR declines with additional output sold, the ’s declines as employment increases. Everything else remains the same as we described above in the discussion of the labor in perfectly competitive labor markets. Given the wage, profit-maximizing firms will hire workers up to the point where the wage equals the product, as shows.
FIGURE 14.6Equilibrium Level of Employment for Firms with PowerFor firms with power in their output , they choose the number of workers, L2, where the going wage equals the ’s product. Note that since is less than , the for labor for a which has power in its output is less than the demand for labor (L1) for a perfectly competitive firm. As a result, employment will be lower in an imperfectly competitive industry than in a perfectly competitive industry. CLEAR IT UP Do Profit Maximizing Employers Exploit Labor? If you look back at , you will see that the pays only the last worker it hires what they’re worth to the . Every other worker brings in more than the pays them. This has sometimes led to the that employers exploit workers because they do not pay workers what they are worth. Let’s think about this . The first worker is worth $x to the , and the second worker is worth $y, but why are they worth that much? It is because of the capital and with which they work. The difference between workers’ worth and their compensation goes to pay for the capital and , without which the workers wouldn’t have a job. The difference also goes to the employer’s profit, without which the would close and workers wouldn’t have a job. The may be earning excessive profits, but that is a different topic of discussion.
What Determines the Going Market Wage Rate?
In the chapter on Labor and Financial Markets, we learned that the has and supply curves like other markets. The for labor curve is a downward sloping function of the wage rate. The for labor is the horizontal sum of all firms’ demands for labor. The supply of labor curve is an upward sloping function of the wage rate. This is because if wages for a particular type of labor increase in a particular , people with appropriate skills may change jobs, and vacancies will attract people from outside the geographic area. The supply of labor is the horizontal summation of all individuals’ supplies of labor.
FIGURE 14.7The Wage RateIn a competitive , the wage and employment level are determined where the for labor equals the supply of labor. Like all prices, the wage rate is determined through the interaction of supply and in the . Thus, we can see in for competitive markets the wage rate and number of workers hired. The FRED database has a great deal of data on labor markets, starting at the wage rate and number of workers hired (https://openstax.org/l/cat10). The United States Census Bureau for the Bureau of Labor Statistics publishes The Current Population Survey, which is a monthly survey of households (you can find a link to it by going to the FRED database found in the previous link), which provides data on labor supply, including numerous measures of the labor force size (disaggregated by age, gender and educational attainment), labor force participation rates for different demographic groups, and employment. It also includes more than 3,500 measures of earnings by different demographic groups. The Current Employment Statistics, which is a survey of businesses, offers alternative estimates of employment across all sectors of the economy. The FRED database, found in the previous link, also has a link labeled "Productivity and Costs" has a wide range of data on productivity, labor costs, and profits across the business sector.
14.2 Wages and Employment in an Imperfectly Competitive Labor Market
LEARNING OBJECTIVES By the end of this section, you will be able to:
- Define power
- Explain how labor markets determine wages and employment, where employers have power
In the chapters on , we observed that while economists use the of as an ideal case of , there are very few examples of perfectly competitive industries in the real world. What about labor markets? How many labor markets are perfectly competitive? There are probably more examples of perfectly competitive labor markets than perfectly competitive product markets, but that doesn’t mean that all labor markets are competitive. When a job applicant is bargaining with an employer for a position, the applicant is often at a disadvantage—needing the job more than the employer needs that particular applicant. John Bates Clark (1847–1938), often named as the first great American economist, wrote in 1907: “In the making of the wages contract the individual laborer is always at a disadvantage. He has something which he is obliged to sell and
Text from Principles of Microeconomics 3e, OpenStax, licensed CC BY-NC-SA 4.0. Access for free at openstax.org.
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