Chapter 7: Labor Economics

The Markets for the Factors of Production

• Factors of production are the inputs used to produce goods and

services.
• The demand for a factor of production is a derived demand.
• A firm’s demand for a factor of production is derived from its
decision to supply a good in another market.
• Labor markets, like other markets in the economy, are governed
by the forces of supply and demand.
 Figure 1 The Versatility of Supply and Demand

(a) The Market for Apples (b) The Market for Apple Pickers

Price of Wage of
Apples Apple
Pickers
Supply Supply

P W

Demand Demand

0 Q Quantity of 0 L Quantity of
Apples Apple Pickers

Copyright©2003 Southwestern/Thomson Learning

 THE DEMAND FOR LABOR

• Most labor services, rather than being final goods ready to be

enjoyed by consumers, are inputs into the production of other
goods.
• The production function illustrates the relationship between
the quantity of inputs used and the quantity of output of a
good.
Table 1 How the Competitive Firm Decides How Much Labor to Hire

Copyright©2004 South-Western
 Figure 2 The Production Function

Quantity
of Apples
Production
300 function
280

240

180

100

0 1 2 3 4 5 Quantity of
Apple Pickers

Copyright©2003 Southwestern/Thomson Learning

The Production Function and the Marginal Product of Labor

• The marginal product of labor is the increase in the amount of

output from an additional unit of labor.
• MPL = Q/L
• MPL = (Q2 – Q1)/(L2 – L1)
The Production Function and the Marginal Product of Labor
• Diminishing Marginal Product of Labor
• As the number of workers increases, the marginal product of labor
declines.
• As more and more workers are hired, each additional worker
contributes less to production than the prior one.
• The production function becomes flatter as the number of
workers rises.
• This property is called diminishing marginal product.
The Production Function and the Marginal Product of Labor
• Diminishing marginal product refers to the property
whereby the marginal product of an input declines as the
quantity of the input increases.
• The value of the marginal product is the marginal product
of the input multiplied by the market price of the output.
VMPL = MPL  P
 Table 1 How the Competitive Firm Decides How Much
Labor to Hire
⼀
Q =Ψ
30
Q = (W

4 $ 150
30 10
Copyright©2004 South-Western
The Value of the Marginal Product and the Demand for Labor

• The value of the marginal product (also known as marginal

revenue product) is measured in dollars.
• It diminishes as the number of workers rises because the
market price of the good is constant.
The Value of the Marginal Product and the Demand for Labor
• To maximize profit, the competitive, profit-maximizing
firm hires workers up to the point where the value of the
marginal product of labor equals the wage.
VMPL = Wage
• The value-of-marginal-product curve is the labor demand
curve for a competitive, profit-maximizing firm.
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↑ 1 个 workr output ↑ ?
UMPI :

marginal product x marat pnice manginalppodut

 Figure 3 The Value of the Marginal Product of Labor

Value
of the
Marginal
Product

Market
wage

Value of marginal product

(demand curve for labor)

0 Profit-maximizing quantity Quantity of

Apple Pickers

Copyright©2003 Southwestern/Thomson Learning

 FYI—Input Demand and Output Supply

• 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 the
marginal cost.
• What Causes the Labor Demand Curve to Shift?
• Output Price
• Technological Change
• Supply of Other factors
 THE SUPPLY OF LABOR
• The labor supply curve reflects how workers’ decisions about
the labor-leisure tradeoff respond to changes in opportunity
cost.
• An upward-sloping labor supply curve means that an increase
in the wages induces workers to increase the quantity of labor
they supply.
 Figure 4 Equilibrium in a Labor Market

Wage
(price of
labor)
Supply

0 Quantity of
Labor

Copyright©2003 Southwestern/Thomson Learning

What Causes the Labor Supply Curve to Shift?

• Changes in Tastes
• Changes in Alternative Opportunities
• Immigration
 EQUILIBRIUM IN THE LABOR MARKET

• The wage adjusts to balance the supply and demand for labor.
• The wage equals the value of the marginal product of labor.
 Figure 4 Equilibrium in a Labor Market

Wage
(price of
labor)
Supply

Equilibrium
wage, W

Demand

0 Equilibrium Quantity of
employment, L Labor

Copyright©2003 Southwestern/Thomson Learning

 EQUILIBRIUM IN THE LABOR MARKET

• Labor supply and labor demand determine the equilibrium

wage.
• Shifts in the supply or demand curve for labor cause the
equilibrium wage to change.
 Figure 5 A Shift in Labor Supply

Wage
(price of 1. An increase in
Supply, S labor supply . . .
labor)
S

2. . . . reduces
the wage . . .
Demand

0 L L Quantity of
Labor
3. . . . and raises employment.

Copyright©2003 Southwestern/Thomson Learning

Shifts in Labor Supply

• An increase in the supply of labor :

• Results in a surplus of labor.
• Puts downward pressure on wages.
• Makes it profitable for firms to hire more workers.
• Results in diminishing marginal product.
• Lowers the value of the marginal product.
• Gives a new equilibrium.
 Figure 6 A Shift in Labor Demand

Wage
(price of Supply
labor)

1. An increase in
labor demand . . .
W

2. . . . increases
the wage . . . D

Demand, D

0 L L Quantity of
Labor
3. . . . and increases employment.

Copyright©2003 Southwestern/Thomson Learning

Shifts in Labor Demand

• An increase in the demand for labor :

• Makes it profitable for firms to hire more workers.
• Puts upward pressure on wages.
• Raises the value of the marginal product.
• Gives a new equilibrium.
Table 2 Productivity and Wage Growth in the United States.

Copyright©2004 South-Western
 ⼟地 資资本
OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL

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• Capital refers to the equipment and structures used to produce

goods and services.
• 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.
OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL
• Prices of Land and Capital
• The purchase price is what a person pays to own a factor of
production indefinitely.
• The rental price is what a person pays to use a factor of
production for a limited period of time.
• The rental price of land and the rental price of capital are
determined by supply and demand.
• The firm increases the quantity hired until the value of the
factor’s marginal product equals the factor’s price.
 Figure 7 The Markets for Land and Capital

(a) The Market for Land (b) The Market for Capital

Rental Rental
Price of Price of
Land Supply Capital Supply

P P

Demand
Demand

0 Q Quantity of 0 Q Quantity of
Land Capital

Copyright©2003 Southwestern/Thomson Learning

Equilibrium in the
• Each factor’s Markets
rental price for
mustLand and
equal Capital
the value of its marginal
product.
• They each earn the value of their marginal contribution to the
production process.
• Factors of production are used together.
• The marginal product of any one factor depends on the quantities of
all factors that are available.
• A change in the supply of one factor alters the earnings of all
the factors.
• A 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.
 Earnings and Discrimination
• Differences in Earnings in the United States Today
• The typical physician earns about $200,000 a year.
• The typical police officer earns about $50,000 a year.
• The typical farm worker earns about $20,000 a year.
• What causes earnings to vary so much?
• Wages are governed by labor supply and labor demand.
• Labor demand reflects the marginal productivity of labor.
• In equilibrium, each worker is paid the value of his or her marginal
contribution to the economy’s production of goods and services.
SOME DETERMINANTS OF EQUILIBRIUM WAGES

• Compensating differentials
• Human capital
• Ability, effort, and chance
• Signaling
• The superstar phenomenon
Compensating Differentials
• Compensating differential refers to a difference in wages
that arises from nonmonetary characteristics of different
jobs.
• Coal miners are paid more than others with similar levels of
education.
• Night shift workers are paid more than day shift workers.
• Professors are paid less than lawyers and doctors.
• Human capital is the accumulation of investments in
people, such as education and on-the-job training.
• The most important type of human capital is education.
Human Capital

• Education represents an expenditure of resources at one point

in time to raise productivity in the future.
• By the year 2000, a man with a college degree earned more
than 89 percent more than without one. Women showed a 70
percent increase in earnings due to a college degree.
Table 1 Average Annual Earnings by Educational Attainment

Copyright©2004 South-Western
• Why has the gap in earnings between skilled and unskilled
workers risen in recent years?
• International trade has altered the relative demand for skilled and
unskilled labor.
• Changes in technology have altered the relative demand for skilled
and unskilled labor.
• Natural ability is important for workers in all occupations.
• Many personal characteristics determine how productive
workers are and, therefore, play a role in determining the
wages they earn.
An Alternative View of Education: Signaling
• Firms use educational attainment as a way of sorting between
high-ability and low-ability workers.
• It is rational for firms to interpret a college degree as a signal of ability.
• Superstars arise in markets that exhibit the following
characteristics:
• Every customer in the market wants to enjoy the good supplied by
the best producer.
• The good is produced with a technology that makes it possible for the
best producer to supply every customer at a low cost.
Mane as a Signal of Power?
Above-Equilibrium Wages: Minimum-Wage Laws, Unions, and
Efficiency Wages
• Why are some workers’ wages set above the level that brings
supply and demand into equilibrium?
• Minimum-wage laws
• Market power of labor unions
• Efficiency wages
Above-Equilibrium Wages: Minimum-Wage Laws, Unions, and
Efficiency Wages
• Unions
• A union is a worker association that bargains with employers over
wages and working conditions.
• Strike
• A strike refers to the organized withdrawal of labor from a firm by a
union.
Above-Equilibrium Wages: Minimum-Wage Laws, Unions, and
Efficiency Wages
• Efficiency Wages
• The theory of efficiency wages holds that a firm can find it
profitable to pay high wages because doing so increases the
productivity of its workers. High wages may:
• reduce worker turnover.
• increase worker effort.
• raise the quality of workers that apply for jobs at the firm.
 THE ECONOMICS OF DISCRIMINATION
• Discrimination occurs when the marketplace offers different
opportunities to similar individuals who differ only by race,
ethnic group, sex, age, or other personal characteristics.
• Although discrimination is an emotionally charged topic,
economists try to study the topic objectively in order to
separate myth from reality.
Measuring Labor-Market Discrimination
• Discrimination is often measured by looking at the average wages
of different groups.
• Even in a labor market free of discrimination, different people have
different wages.
• People differ in the amount of human capital they have and in the
kinds of work they are willing and able to do.
• Simply observing differences in wages among broad groups—white
and black, men and women—says little about the prevalence of
discrimination.
Table 2 Median Annual Earnings by Race and Sex

Copyright©2004 South-Western
Measuring Labor-Market Discrimination
• Because the differences in average wages among groups in
part reflect differences in human capital and job
characteristics, they do not by themselves say anything
about how much discrimination there is in the labor market.
• Two field experiments
• Goldin and Rouse (2000)
• Bertrand and Mullainathan (2004)
Discrimination by Employers
• Firms that do not discriminate will have lower labor costs
when they hire the employees discriminated against.
• Nondiscriminatory firms will tend to replace firms that
discriminate.
• Competitive markets tend to limit the impact of
discrimination on wages.
• Firms that do not discriminate will be more profitable
than those firms that do discriminate.
不歧视的企业在雇佣遭到歧视的员⼯时，劳动成本会较低。
• 不歧视的企业往往会取代歧视性企业。
• 竞争市场往往会限制歧视对⼯资的影响。
• 不歧视的企业将比歧视性企业更具盈利能⼒。
Discrimination by Customers and Governments

• Although the profit motive is a strong force acting to eliminate

discriminatory wage differentials, there are limits to its
corrective abilities.
• Customer preferences
• Government policies
Discrimination by Customers and Governments
• Customer preferences:
• If customers have discriminatory preferences, a competitive market is
consistent with a discriminatory wage differential.
• This will happen when customers are willing to pay to maintain the
discriminatory practice.
• Government policies:
• When the government mandates discriminatory practices or requires
firms to discriminate, this may also lead to discriminatory wage
differentials.