Labor Market

1. Labor is treated like any other good in the market, except demand comes from the firm instead of the consumer.

2. The price a firm pays for labor is known as the wage. In addition to a wage, workers also commonly receive fringe benefits such as insurance and vacation time.

   1. Real wage: Wage adjusted for inflation.

 

Demand

1. The demand curve for the labor market shows how much labor firms will buy at each wage.

2. Firms must determine how much labor is needed for a profit-maximizing level of production.

3. Marginal revenue product (MRP): Revenue increase resulting from the purchase of an additional unit of labor.

   1. The firm maximizes profits by purchasing additional labor until the MRP is equal to the market wage.

   2. If the costs of any factors necessary to produce a good change, the MRP will be affected and the amount of labor demanded by the firm will also change.

4. Adding up all the firms’ labor demand curves will equal the market labor demand curve.

5. If demand increases (decreases) for a good that a particular type of labor produces, the demand for that type of labor will also increase (decrease).

 

Supply

1. The supply curve for the labor market shows how much labor workers or households will provide at each wage.

2. There are two alternatives for each household’s time: leisure and working at home.

3. As the market wage changes, decisions concerning work will also change. There are two effects of a wage change, which work in opposite directions:

   1. Substitution effect: If the marginal benefit of leisure or working at home is higher than the market wage, the household should choose either leisure or working at home. This means that as the wage rises (falls), households are more (less) likely to choose the labor market.

   2. Income effect: As the wage rises (falls), households are less (more) likely to spend more time in labor market. With a higher (lower) wage, they can work less (more) to make the same income.

4. The relative strengths of the income and substitution effects will determine the shape of the household’s labor supply curve.

   1. If the substitution effect is stronger, the curve will be upward sloping.

   2. If the income effect is stronger, the curve will be downward sloping.

   3. If the substitution and income effects are equal, the curve will be vertical.

5. Most people have a backward-bending labor supply curve, which is upward sloping for low wages, vertical or nearly vertical at higher wages, and bends backward with a downward slope for the highest wages.

6. Market labor supply, on the other hand, is a straight, upward sloping line. It is not backward-bending because, as a whole, more workers will be attracted to higher-paying jobs.

 

Equilibrium

1. As with other goods, the supply and demand for labor create an equilibrium wage rate and quantity in the market when they are equal.

2. There are several possible inefficiencies, which may cause the wage to differ from equilibrium:

   1. Income tax: Workers pay a tax on their income, and it affects the amount of time they are willing to work.

   2. Minimum wage: The government sets in the market a minimum wage, which firms are forced to pay.

      1. If the minimum wage is lower than the market equilibrium wage, then there is no impact because firms will pay the equilibrium wage.

      2. If the minimum wage is higher than the market equilibrium wage, labor supplied will be higher than labor demanded, and some workers will be unable to find jobs.

   3. Discrimination: Firms may choose to hire or set wages based on factors that are not related to productivity, such as race, age, or gender. Nonprofit maximizing decisions are inefficient.

   4. Unions By bargaining with firms for higher wages, unions decrease demand for labor. Some workers will then move to nonunion firms, which can compete with lower costs because they pay lower wages. However, union firms often have other benefits that offset the higher cost of labor, such as lower turnover.