Chapter 18

In certain cases, the labor-supply might not slope upwards.

For example, if you get a raise, then although this means technically that the OC of leisure is greater, you are wealthier and can decide to enjoy more leisure.

Changes in Tastes

For example, sixty years ago it was not the norm for women to go out and work; but now, since times are changing, mothers choose to work

Shifts in Labor Demand

Suppose that an increase in the popularity of apples causes their price to rise. This price increase does not change the marginal product of labor for any given number of workers, but it does raise the value of the marginal product. With a higher price for apples, hiring more apple pickers is now profitable.

Capital Income (Review this some more in the reading)

The rent that households receive for the use of their capital. These earnings from capital, however, are paid to households eventually in a variety of forms. Some of the earnings are paid in the form of interest to those households that have lent money to firms. Bondholders and bank depositors are two examples of recipients of interest. Thus, when you receive interest on your bank account, that income is part of the economy's capital income. Some of the earnings from capital are paid to households in the form of dividends. Dividends are payments by a firm to the firm's stockholders.

Labor income

The paycheck that workers get from their employers.

The Supply of Other Factors

The quantity available of one factor of production can affect the marginal product of other factors. A fall in the supply of ladders, for instance, will reduce the marginal product of apple pickers and thus the demand for apple pickers.

Capital

The stock of equipment and structures used for production. That is, the economy's capital represents the accumulation of goods produced in the past that are being used in the present to produce new goods and services. For our apple firm, the capital stock includes the ladders used to climb the trees, the trucks used to transport the apples, the buildings used to store the apples, and even the trees themselves.

The value of the marginal product

depends on the number of workers

The VMPL line slopes downwards because of

diminishing marginal product (the marginal product of labor diminishes as the number of workers rises.)

A profit maximizing firm

does not directly care about the number of workers it has or the number of apples it produces. It cares only about profit (which equals the TR from the sale of apples minus the TC of producing them)

As long as the firms using the factors of production are competitive and profit-maximizing,

each factor's rental price must equal the value of the marginal product for that factor. Labor, land, and capital each earn the value of their marginal contribution to the production process.

When the market is in this equilibrium,

each firm has bought as much labor as it finds profitable at the equilibrium wage. That is, each firm has followed the rule for profit maximization: It has hired workers until the value of the marginal product equals the wage.

Because the demand curve reflects the value of the marginal product of labor,

in equilibrium workers receive the value of their marginal contribution to the production of goods and services.

Most labor services are

inputs into the production of other goods

A competitive firm is a

price taker (it takes the price and wage as given by market conditions. It only has to decide how many apples to sell and how many workers to hire.)

The labor-supply curve

reflects how workers' decisions about the labor-leisure trade-off respond to a change in that opportunity cost.

In the market for apples, the firm is a _______; in the market for apple pickers, the firm is a _______

seller; buyer

An upward-sloping labor-supply curve means

that an increase in the wage induces workers to increase the quantity of labor they supply.

Because the market price (P) is constant for a competitive firm while the marginal product (MP) declines with more workers,

the value of the marginal product diminishes as the number of workers rises.

A competitive, profit-maximizing firm hires workers up to the point at which

the value of the marginal product of labor (VMPL) equals the wage.

For a competitive, profit-maximizing firm,

the value-of-marginal-product curve is also the firm's labor-demand curve.

To find the worker's contribution to revenue,

we must convert the MPL (which is measured in bushels of apples) into the value of the marginal product (which is measured in dollars)

So far we have established two facts about how wages are determined in competitive labor markets:

- The wage adjusts to balance the supply and demand for labor. - The wage equals the value of the marginal product of labor.

What causes the Labor-Supply Curve to Shift:

- Changes in Tastes - Changes in Alternative Opportunities - Immigration

A few things that might shift the Labor-Demand Curve:

- The Output Price - Technological Change - The Supply of Other Factors

We make two assumptions about our firm:

1. It is competitive. 2. It is profit maximizing

Three categories of the firm's factors of production

1. Labor 2. Land 3. Capital

VMPL

= P x MPL. Basically the market price of the output multiplied by the marginal product of the input.

Marginal Profit (∆Profit)

= VMPL - W. Basically, the worker's contribution to revenue minus the worker's wage.

MPL

= ∆Q/∆L. It is the increase in the amount of output from an additional unit of labor.

Monopsony

A labor market in a small town dominated by a single, large employer. That employer can exert a large influence on the going wage, and it may well use that market power to alter the outcome. Such a market in which there is a single buyer is called a monopsony.

The Output Price

An increase in the Price of apples, raises the Value of the Marginal Product of each worker who picks apples, and increases Labor Demand from the firms that supply apples. Conversely, a decrease in the Price of apples reduces the Value of the Marginal Product and decreases Labor Demand.

A monopsony (a market with one buyer) is in many ways similar to a monopoly (a market with one seller).

Both markets hire fewer workers than would a competitive firm; by reducing the number of jobs available, the monopsony firm moves along the labor supply curve, reducing the wage it pays and raising profits. Thus, both monopolists and monopsonists reduce economic activity in a market below the socially optimal level. In both cases, the existence of market power distorts the outcome and causes deadweight losses. Overall, monopsonies are rare.

The rental price and the purchase price are related:

Buyers are willing to pay more for a piece of land or capital if it produces a valuable stream of rental income. The equilibrium rental income at any point in time equals the value of that factor's marginal product. Therefore, the equilibrium purchase price of a piece of land or capital depends on both the current value of the marginal product and the value of the marginal product expected to prevail in the future.

Review:

In a competitive labor market, there are many buyers and sellers of labor, so each buyer or seller has a negligible effect on the wage.

We have just seen how such a firm decides how much labor to hire:

It chooses the quantity of labor at which the wage equals the value of the marginal product.

Diminishing marginal product is closely related to

Marginal Cost. If MPL rises, MC decreases; If MPL falls, MC increases.

Immigration

Movement of workers from region to region, or country to country, is another important source of shifts in labor supply. When immigrants come to the United States, the supply of labor in the United States increases, and the supply of labor in the immigrants' home countries falls.

W/MPL=MC, therefore, we can substitute to obtain

P=MC. Thus, when a competitive firm hires labor up to the point at which the Value of the Marginal Product equals the Wage, it also produces up to the point at which the Price equals Marginal Cost.

Shifts in Labor Supply

Suppose that immigration increases the number of workers willing to pick apples. The supply of labor shifts to the right from S1 to S2. At the initial wage W1, the quantity of labor supplied now exceeds the quantity demanded, and it creates a surplus of labor which puts downward pressure on the wage of apple pickers, and the fall in the wage from W1 to W2 makes it profitable for firms to hire more workers. As the number of workers employed in each apple orchard rises, the MP of a worker falls, and so does the value of the marginal product. In the new equilibrium, both the wage and the value of the MP of labor are lower than they were before the influx of new workers.

Technological Change

Technological advance typically raises the Marginal Product of Labor, which in turn increases the demand for labor and shifts the Labor-Demand curve to the right. It is also possible for technological change to reduce Labor Demand. The invention of a cheap industrial robot, for instance, could conceivably Reduce the Marginal Product of Labor, shifting the Labor-Demand curve to the left. Economists call this labor-saving technological change. History suggests, however, that most technological progress is instead labor-augmenting.

Changes in Alternative Opportunities

The supply of labor in any one labor market depends on the opportunities available in other labor markets. If the wage earned by pear pickers suddenly rises, some apple pickers may choose to switch occupations, causing the supply of labor in the market for apple pickers to fall.

The market wage line is horizontal. To maximize profit, the firm hires workers up to the point where these two curves cross. Below this level of employment, ____________________; Above this level of employment, __________________

VMPL > wage, so hiring another worker would increase profit; VMPL < wage, so the marginal worker is unprofitable.

Prosperity for firms in an industry is often linked to prosperity for workers in that industry

When the price of apples rises, apple producers make greater profit, and apple pickers earn higher wages. When the price of apples falls, apple producers earn smaller profit, and apple pickers earn lower wages.

Because of diminishing marginal product,

a factor in abundant supply has a low marginal product and thus a low price, and a factor in scarce supply has a high marginal product and a high price. As a result, when the supply of a factor falls, its equilibrium price rises.

To make its hiring decision, a firm must consider how the size of its workforce affects the

amount of output produced

Input is ________; output is _______

apple pickers; apples

An event that changes the supply of any factor of production

can alter the earnings of all the factors. The change in earnings of any factor can be found by analyzing the impact of the event on the value of the marginal product of that factor.

As the quantity of the input increases, the production function gets

flatter, representing diminishing marginal product. As the number of workers increase, each additional worker contributes less to the production of apples/

The firm's supply of apples and its demand for workers are derived from

its primary goal of maximizing profit.

Because time is limited,

more work means less leisure.

Any event that changes the supply or demand for labor

must change the equilibrium wage and the value of the marginal product by the same amount because these must always be equal.

According to the neoclassical theory of distribution

the amount paid to each factor of production depends on the supply and demand for that factor. The demand, in turn, depends on that particular factor's marginal productivity. In equilibrium, each factor of production earns the value of its marginal contribution to the production of goods and services. The neoclassical theory of distribution is widely accepted.

When labor supply increases from S1 to S2, perhaps because of an immigration of new workers,

the equilibrium wage falls from W1 to W2. At this lower wage, firms hire more labor, so employment rises from L1 to L2. The change in the wage reflects a change in the value of the marginal product of labor: With more workers, the added output from an extra worker is smaller.

When labor demand increases from D1 to D2, perhaps because of an increase in the price of the firm's output,

the equilibrium wage rises from W1 to W2, and employment rises from L1 to L2. The change in the wage reflects a change in the value of the marginal product of labor: With a higher output price, the added output from an extra worker is more valuable.

Labor supply and labor demand together determine

the equilibrium wage, and shifts in the supply or demand curve for labor cause the equilibrium wage to change. At the same time, profit maximization by the firms that demand labor ensures that the equilibrium wage always equals the value of the marginal product of labor.

Marginal Revenue Product

the extra revenue the firm gets from hiring an additional unit of a factor of production.

For both land and capital,

the firm increases the quantity hired until the value of the factor's marginal product equals the factor's price. Thus, the demand curve for each factor reflects the marginal productivity of that factor.

The Purchase Price of land or capital is

the price a person pays to own that factor or production.

The rental price is

the price a person pays to use that factor for a limited period of time.

Factors of production are used together in a way that makes

the productivity of each factor depend on the quantities of the other factors available for use in the production process. As a result, when some event changes the supply of any one factor of production, it will typically affect not only the earnings of that factor but also the earnings of all the factors as well.