chapter 13 labor markets © 2004 thomson learning/south-western

Chapter 13

Labor Markets

© 2004 Thomson Learning/South-Western

2

Marginal Productivity Theory of Input Demand

Input prices are also determined by the forces of supply and demand.

The firms are on the demand side while the supply comes from individuals.

The theory of input demand relies on Ricardo’s theory of marginal productivity.

3

Profit-Maximizing Behavior and the Hiring of Inputs

A profit-maximizing firm will hire additional units of any input up to the point at which the additional revenue from hiring one more unit is exactly equal to the cost of hiring that unit.

Let MEK and MEL denote the marginal expense of hiring capital and labor, respectively.

4

Profit-Maximizing Behavior and the Hiring of Inputs

Let MRK and MRL be the extra revenue that hiring more units of capital and labor allows the firm to bring in.

Profit maximizing behavior requires:

.LL

KK

MRMR

MRME

5

Price-Taking Behavior

If the firm is a price taker in the capital and labor market then it can always hire an extra unit of capital at the prevailing rate (v) and an extra unit of labor at the wage rate (w).

.LL

KK

MRMEw

MRMEv

6

Marginal Revenue Product

Marginal product is how much output the additional input can produce.

Marginal revenue (MR) is the extra revenue obtained from selling an additional unit of output.

Thus, the profit maximizing rules are:

.MRMPMRMEw

MRMPMRMEv

LLL

KKK

7

Marginal Revenue Product

The marginal revenue product of labor and capital are the extra revenue obtained from selling the output produced by hiring an extra worker or machine.

These show how much extra revenue is brought in by hiring one more unit of an input.

8

A Special Case--Marginal Value Product

If the firm is also a price taking in the goods market, marginal revenue equals the price (P) at which the output sells.

The profit maximizing conditions become

PMPw

PMPv

L

K

9

Marginal Value Product

The marginal value product (MVP) of capital and labor, respectively, are special cases of marginal revenue product in which the firm is a price taker for its output.

L

K

MVPw

MVPv

10

APPLICATION 13.1: Hiring by Nonprofit Firms

Most hospitals in the U.S. operate on a not-for-profit basis.

In some cases hospitals are owned by public corporations and presumably strive for maximum profits.

Economists have found important differences in the labor demand for these two types of institutions.

11


Some of the differences may relate to a “quality bias” for non-profit hospitals.

Such hospitals seem to hire more high-wage labor (physicians) and less lower-wage labor (nurses) than do for-profit hospitals.

One explanation for this result may be that nonprofit hospitals are run by physicians who gain utility from high-quality (high-cost) surroundings which the managers of for-profit hospitals have a more “bottom line” mentality.

12


Virtually all colleges and universities are operated as nonprofit institutions.

It is not surprising that faculty hiring does not follow the principles of profit maximization.

On most campuses, more than 50% of the faculty has the rank of full professor but, on average, full professors are paid nearly twice as much as assistant professors and instructors.

13

Responses to Changes in Input Prices: Single Variable input Case

Assume the firm has fixed capital and can only vary its labor input in the short run.

Labor will exhibit diminishing marginal physical productivity so labor’s MVP will decline as more labor is hired.

In Figure 13.1, the profit maximizing firm will hire L1 labor hours when the wage rate is w1.

14

MVPWage

MVPL

w1

Labor hours0 L1 L2

w2

FIGURE 13.1: Change in Labor Input When Wage Falls: Single Variable Case

15

Responses to Changes in Input Prices: Single Variable input Case

If the wage rate falls to w2 the firm hires increased labor out to L2.– If the firm continued to hire L1 it would not be

maximizing profit since labor would be capable of producing more in additional revenue than hiring additional labor would cost.

With one variable input, diminishing marginal productivity results in a downward sloping demand curve.

16

A Numerical Example

Table 13.1 shows the productivity for Hamburger Heaven when it uses four grills

The marginal product declines as more workers are assigned to the grills

Marginal Revenue Product is simply price, $1.00 times the marginal product.

At a wage of $5.00, the firm should hire four workers.

17

TABLE 13.1: Hamburger Heaven’s Profit-Maximizing Hiring Decision

Labor Input

per Hour

Hamburgers Produced per Hour

Marginal Product

(Hamburger)

Marginal Value Product

($1.00 per Hamburger)

1 20.0 20.0 $20.00 2 28.3 8.3 8.30 3 34.6 6.3 6.30 4 40.0 5.4 5.40 5 44.7 4.7 4.70 6 49.0 4.3 4.30 7 52.9 3.9 3.90 8 56.6 3.7 3.70 9 60.0 3.4 3.40 10 63.2 3.2 3.20

18

The Substitution Effect

The substitution effect, in the theory of production, is the substitution of one input for another while holding output constant in response to a change in the input’s price.

In Figure 13.2(a), a fall in w will cause the firm to change from input combination A to B to equate RTS to the new w/v.

Diminishing RTS leads to more labor hired.

19

Capitalper week

MC

K1

K2

A

q1

Labor hoursper week

0 L1 L2

(a) Input Choice

Price

P

Outputper week

0 q1

(b) Output Decision

FIGURE 13.2: Substitution and Output Effects of A Decrease in Price of Labor

20

Capitalper week

MC

K1

K2

A

q1B

Labor hoursper week

0 L1 L2

(a) Input Choice

Price

P

Outputper week

0 q1

(b) Output Decision


21

The Output Effect

The output effect is the effect of an input price change on the amount of the input that the firm hires that results from a change in the firm;s output level.

In Figure 13.2(b), the lower w causes the marginal cost curve to shift to MC’.

The profit maximizing output raises to q2 resulting in more labor hired.

22

Capitalper week

MC’MC

K1

K2

A

q1B

Labor hoursper week

0 L1 L2

(a) Input Choice

Price

P

Outputper week

0 q1 q2

(b) Output Decision


23

Capitalper week

MC’MC

K1

K2

AC

q2

q1B

Labor hoursper week

0 L1 L2

(a) Input Choice

Price

P

Outputper week

0 q1 q2

(b) Output Decision


24

Summary of Firm’s Demand for Labor

A fall in the wage rate will cause the firm to hire more labor for two reasons:– The firm will substitute the now cheaper labor for

other inputs that are now relatively more expensive, the substitution effect.

– The decline in wages will lower marginal costs so the profit maximizing firm will produce more output which requires hiring more labor, the output effect.

25

Responsiveness of Input Demand to Price Changes

Ease of Substitution– The size of the substitution effect will depend upon

how easy it is to substitute other factors of production for labor.

– The size of the substitution effect will also depend upon the length of time as it becomes easier to find substitutes in a longer period of time.

26

Costs and the Output Effect

The size of the output effect will depend upon– How large the increase in marginal costs brought

about by the wage rate increase is, and– How much quantity demanded will be reduced by

a rising price.– The first depend upon how important labor is in

production while the latter depends upon the price elasticity of demand for the final product.

27

APPLICATION 13.2: Controversy over the Minimum Wage

The Fair Labor Standards Act of 1938 established a national minimum wage of $.25 per hour.

Each increase raises debate about whether such increases are counterproductive

In Figure 1(a) the equilibrium wage is w1 with l1 units of labor hired.

28

Wage

w1

w2

S

q2

q1

Wage = w1

D

Laborper

week

0 L2

(a) The Market

Capitalper week

Laborper week

0

(b) Typical Firm

l1

FIGURE 1: Effects of a Minimum Wage in a Perfectly Competitive Labor Market

29

APPLICATION 13.2: Controversy over the Minimum Wage

A minimum wage of w2 will cause firms to hire less, l2, units of labor while more labor L3 will be supplied

The imposition of a minimum wage will result in an excess supply of labor over the demand for labor of L3 - L2.

30

Wage

w1

w2

S

q2

q1

Wage = w1

Wage= w2

D

Laborper

week

0 L2 L3L1

(a) The Market

Capitalper week

Laborper week

0

(b) Typical Firm

l2 l1

FIGURE 1: Effects of a Minimum Wage in a Perfectly Competitive Labor Market

31

Minimum Wages and Teenage Unemployment

Teenagers are most likely to be affected by minimum wage laws because their skills are usually at the lower end of the spectrum.– While many factors are at play, a major study in the

1970s found that a 1-percent increase resulted in a 0.3 percent reduction in teenage employment.

– Minority group members have rates that exceed 30 percent.

32

Recent Disputes over the Evidence

A 1994 study by Card and Krueger challenged the belief that minimum wages reduced employment opportunities.– Their study of fast-food restaurants in New Jersey

and Pennsylvania found no negative effects on employment.

– However, an analysis of different data from these states found negative employment effects

33

Input Supply

Resources come from three major sources:– Labor is provided by individuals.– Capital equipment is produced which other firms

can buy outright or rent.– Natural resources are extracted from land and can

be used outright or sold to other firms.

As shown in earlier chapters, capital and natural resources have upward sloping supply curves.

34

Labor Supply and Wages

Wages represent the opportunity cost of not working at a paying job for individuals.

For purposes of this analysis, wages should be interpreted to include all forms of compensation.

Individuals will balance the monetary rewards from working against the psychic benefits of other, nonpaid activities.

35

Labor Supply and Wages

Labor supply curves will differ based upon individual preferences.– Noneconomic factors such as pleasant working

conditions will affect the location of the supply curve.

It is likely that an increase in the wage will result in more labor supplied to the market.– Graphically, the market labor supply curve is likely

to be positively sloped.

36

Equilibrium Input Price Determination

In Figure 13.3, the market demand for labor is labeled D, and the market supply of labor is labeled S.

The equilibrium wage and quantity is where quantity demanded equals quantity supplied, [w*, L*].

Other things equal, this equilibrium will tend to persist from period to period.

37

Wage

D

S

w*

Labor hours per week

0 L*

FIGURE 13.3: Equilibrium in an Input Market

38

Shifts in Demand and Supply

Any factor that shifts the firms’ underlying production function will shift its input demand curve.

Since the demand for an input is derived from the demand for the output, changes in the prices of the output will shift input demand curves

39

Shifts in Demand and Supply

In Figure 13.3, the demand curve shifts to D’ which reduces equilibrium wages from w* to w’ and equilibrium employment from L* to L’.

The various factors that shift input demand and supply curves are summarized in Table 13.2.

40

Wage

D’

D

S

w’

w*

Labor hours per week

0 L’ L*

FIGURE 13.3: Equilibrium in an Input Market

41

TABLE 13.2: Factors That Shift Input Demand and Supply Curves

Demand Labor Supply Capital Supply Demand Shifts Outward Supply Shifts Outward

Rise in output price Decreased preference for Leisure

Fall in input costs of equipment makers

Increase in marginal productivity

Increased desirability of job

Technical progress in making equipment

Demand Shifts Inward Supply Shifts Inward Fall in output price Increased preference

for Leisure Rise in input costs of

equipment makers Decrease in marginal

productivity Decreased desirability

of job

42

APPLICATION 13.3: Why is Wage Inequality Increasing?

Wage inequality has a long history, but seems to have increased recently.

Measuring Wage Inequality– To control for differences in hours, researchers look

at “full-time, year-round” workers.– Usually, they concentrate on one gender and try to

include total wages including fringe benefits.– A common approach is to compare workers in the

90th to workers in the 10th percentile.

43


U.S. studies for the 1965-1995 period find– The 90/10 ratio in 1965 stood at about 4.3 for

male, full-time, year round workers.– By 1995, this 90/10 ratio had increased to 5.4.

European countries have also experienced an increase in inequality although only the United Kingdom has had increases similar to the U.S.

44


Factors that increase the supply of low-wage workers or increase the demand for high-wage workers would help to explain these trends.

Two Important Trends– A sharp increase in the relative demand for

technically skilled workers which partially explains the rising wages of college graduates.

45


– The second factor, which explains less of the trend, is that there has also been a decline in the demand for low-wage workers.

Two reasons for the decline– A decline in the importance of manufacturing

industries in the overall economy, and– Sustained increases in imports of goods that are

produced primarily with unskilled labor

46


Trends in labor supply have exacerbated the demand effects.– Large (legal and illegal) immigrations in the 1990s

may have increased the supply of low-wage workers.

– The increase in labor supply of women has probably had its greatest impact on low-wage men.

47

Monopsony

If the firm is not a price taker in the input market, it may have to offer a higher wage to attract more employees.

A monopsony is the condition in which one firm is the only hirer in a particular input market.

If the firm is a monopsony, it faces the entire market supply curve for the input.

48

Marginal Expense

The marginal expense of an input is the cost of hiring one more unit of an input.– The firm has to offer a higher wage to the hired

worker and to the workers already employed. – The marginal expense of labor (MEL) will exceed

the price of the input if the firm faces an upward-sloping supply curve for the input.

49

A Numerical Illustration

Suppose the Yellowstone Park Company is the only hirer of bear wardens.

The number of people willing to take this job (L) is given by

This relationship is shown in Table 13.3

wL2

1

50

TABLE 13.3: Labor Costs of Hiring Bear Wardens in Yellowstone Park

Hourly Wage

Workers Supplied per Hour

Total Labor Cost per

Hour

Marginal Expense

$2 1 $2 $2 4 2 8 6 6 3 18 10 8 4 32 14 10 5 50 18 12 6 72 22 14 7 98 26

51


Total labor costs (w·L) is shown in the third column and the marginal expense of hiring each warden is shown in the fourth column.

Since the new warden and the existing wardens receive the wage increase, the marginal expense exceeds the wage rate.

52


Figure 13.4 shows the supply curve (S) for wardens.– If Yellowstone wishes to hire three wardens it must

pay $6 per hour with total outlays of $18 (point A on the graph).

– The wage must be increased to $8 to get a fourth warden (point B) which results in total outlays of $32.

53

Hourlywage

S

A

B

6

$8

Bear wardens per hour

0 3 4

FIGURE 13.4: Marginal Expense of Hiring Bear Wardens

54


The marginal expense of the fourth warden, $14 is reflected in the graph.– The hourly wage ($8) is shown in gray.– The extra outlay to the three previous workers ($8

per hour versus $6 per hour previously) is shown in color.

– Total outlays exceed the amount for three wardens by the sum of these two areas.

55

Hourlywage

S

A

B

6

$8

Bear wardens per hour

0 3 4

FIGURE 13.4: Marginal Expense of Hiring Bear Wardens

56

Monopsonist’s Input Choice

The profit-maximizing monopsonist will hire up to the point where the additional revenue equals the additional cost of hiring one more unit of input.

For labor this requires:

Only if the firm is a price taker will MEL = w.

L LMVP ME

57

A Graphical Demonstration

The demand curve in Figure 13.5 is D. Since marginal expense (MEL) exceeds the

wage, the marginal expense curve is above the supply curve (S).

L1 is the profit maximizing choice while the marginal value product is MVP1 and the wage is w1.

58

Wage

S

D

ME

Labor hoursper week

0

FIGURE 13.5: Pricing in a Monopsonistic Labor Market

59

Wage

S

D

ME

MVP1

Labor hoursper week

0 L1


60

Wage

S

D

ME

MVP1

w1

Labor hoursper week

0 L1


61

A Graphical Demonstration

L1 is less than L*, the amount hired with perfect competition.

As with a monopoly, the “demand curve” for a monopolist actually consists of the single point given by L1, w1.

62

Wage

S

D

ME

w*

MVP1

w1

Labor hoursper week

0 L*L1


63

Monopsonists and Resource Allocation

Since the monopsonist restrict its input use, it pays an input less than its marginal value product (w1 < MVP1).

Total output could be increased by drawing more labor into the market.

The more inelastic the labor supply, the more the monopsonists can benefit from this profit opportunity.

64

Causes of Monopsony

If competition for inputs is lacking, monopsony may exit.– The input may have high opportunity costs of

moving to another input market.– The input may be so specialized that there is only

one firm that hires that input.– Firms may join together to form a cartel in the input

market.

65

APPLICATION 13.4: Monopsony in the Market for Sports Stars

Because players marginal revenue products are more easily measured and correlated with spectator attendance, sports provides a good market for study.

The “reserve clause” in professional baseball found layers to teams that first signed them giving teams monopsony power.

66

Monopsony in Major League Baseball

In a famous 1974 study, G.W. Scully examined the correlation between a team’s winning percentage and its attendance.

Next, he analyzed what aspects of an individual’s performance most closely related to a team’s overall performance.

He used this information to estimate the MRPs of the players.

67

Monopsony in Major League Baseball

He found the MRPs greatly exceeded players salaries.

A players strike in 1972 and other legal actions led to the adoption of the free-agent provisions that partially replaced the reserve-clause.

This has severely limited the monopsony power of major league teams.

68

Basketball and Michael Jordan

While it did not have a reserve clause, the National Basketball Association (NBA) has exercised some monopsony power.

Early stars probably were most affected, but Michael Jorden’s multimillion dollar salary was millions of dollars less than what he was worth to the NBA in terms of higher television ratings when he played.

69

Bilateral Monopoly

A bilateral monopoly is a market in which both suppliers and demanders have monopoly power.– Pricing is indeterminate in such markets.

In Figure 13.6, “supply” and “demand” intersect at P*, Q*, but this is not equilibrium since neither player is a price taker.

70

Inputprice

S

D

ME

MR

Quantity perperiod

0

FIGURE 13.6: Bilateral Monopoly

71

Bilateral Monopoly

The monopoly supplier will operate on its marginal revenue curve (MR) and prefer price-quantity combination P1, Q1.

72

Inputprice

S

D

ME

MR

P1

Quantity perperiod

0 Q1


73

Bilateral Monopoly


The monopsonistic will operate on its marginal expense curve (ME) and prefer combination P2, Q2.

74

Inputprice

S

D

ME

MR

P*

P2

Quantity perperiod

0 Q2


75

Bilateral Monopoly


The monopsonistic will operate on its marginal expense curve (ME) and prefer combination P2, Q2.

The final outcome, after bargaining, will lie between these two combinations.

76

Inputprice

S

D

ME

MR

P*

P1

P2

Quantity perperiod

0 Q*Q1Q2


chapter 13 labor markets © 2004 thomson learning/south-western

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