Labor Markets

This is Unit Thirteen of Principles of Microeconomics, part one of two: the market where most income is earned, and the rule a firm uses to decide how many workers to hire. Unit twelve ended with resources everyone can take. This unit is the market for the one resource most people sell: an hour of work. The firm is the buyer now, and it hires by the same logic it used to choose output, taking each worker while what that worker adds to revenue covers what that worker costs. The wage comes from the market, and one buyer among many takes it as given. By the end you will be able to say where income comes from and why a firm wants a worker. To compute marginal revenue product and hire by the rule. To show that the hiring rule and the output rule are one. To hire under imperfect competition and derive the market wage. And to describe labor supply, predict wage and employment from a shift, and define monopsony.

Two entries on why firms demand labor: where income comes from, and the revenue a worker brings.

Where income comes from.

MIC 1201 Income Comes from Factor Markets

Income comes from owning resources and selling their services: labor for wages, land for rent, capital for interest. Factor prices are set in factor markets, and for most people the factor is labor; a wage is the price of an hour of work, set by demand and supply. Buyers here are firms and sellers households, so unit two's roles are reversed.

Why a firm wants a worker.

MIC 1202 Why Firms Demand Labor

A firm hires a worker for the revenue the output brings, so it never pays more than what the last worker adds is worth, and marginal product declines as workers share the same capital: eighteen more cars at ten dollars is worth one eighty. Workers in one market are treated as alike, and marginal product belongs to the position, not the person.

Five entries on the hiring rule: the value of the marginal product, the general rule, computing it, what the last worker costs, and the rule itself.

The competitive value.

MIC 1203 Value of the Marginal Product

When the firm sells at a market price, the value of the marginal product is marginal product times price. It falls as marginal product falls, and it is the firm's demand for labor: eighteen cars at ten dollars, one eighty for the fourth worker. Price is the product's, not the wage; the wage is compared with this value, not multiplied in.

The general rule.

MIC 1204 Marginal Revenue Product

The general rule is marginal revenue product: marginal product times marginal revenue. Under competition marginal revenue equals price, so the value of the marginal product is the competitive case, and the exam's term is marginal revenue product; one formula covers both, and only marginal revenue changes. With market power marginal revenue is below price, so marginal revenue product is below the competitive value.

Computing it.

MIC 1205 Building Marginal Revenue Product and Hiring

From a total product table and the product's price, compute marginal product as the change in output from each added worker, then marginal revenue product as marginal product times price. Given the wage, hire every worker whose marginal revenue product is at least the wage and stop at the first who falls short; check by profit, since revenue minus the wage bill should exceed the total at one worker more or fewer. The car wash's total product runs thirty, fifty-six, seventy-eight, ninety-six, one hundred ten, one hundred twenty and one hundred twenty-six cars for one to seven workers, so marginal product is thirty, twenty-six, twenty-two, eighteen, fourteen, ten and six, and at ten dollars a wash marginal revenue product is three hundred down to sixty. At a wage of one hundred fifty a day the fourth worker adds one eighty and is hired, the fifth adds one forty and is not: four workers, revenue nine hundred sixty, wages six hundred. At a wage of one hundred twenty the fifth is hired too. Compute marginal product from the change in total product, not the average, and compare the wage with the last worker's marginal revenue product, not the average of all of them.

What the last worker costs.

MIC 1206 Marginal Factor Cost in a Competitive Labor Market

Marginal factor cost is what one more worker adds to total cost. In a competitive labor market the firm hires all it wants at the going wage, so marginal factor cost equals the wage and is constant; the fiftieth worker costs one fifty, like the first. The firm faces a flat labor supply at the wage, and that constant is the exam's answer.

The hiring rule.

MIC 1207 The Hiring Rule and the Demand for Labor

A firm hires until marginal revenue product equals marginal factor cost; under competition, the wage. The falling part of the marginal revenue product curve is the firm's demand for labor, and a higher wage moves the firm up its curve to fewer workers. Only the falling part is demand, since on the rising part each worker adds more than the last.

Two entries on one rule in two units: why the hiring rule agrees with unit six, and what shifts a firm's demand for labor.

Why this agrees with unit six.

MIC 1208 The Two Rules Lead to the Same Outcome

The hiring rule and the output rule are one rule in two units. Hiring a worker whose marginal revenue product exceeds the wage is producing units whose price exceeds marginal cost, because a unit's marginal cost is the wage divided by marginal product; check it by computing marginal cost per unit for the last worker hired and the first not hired and comparing each with the price. At one hundred fifty a day and ten dollars a wash the car wash hires four workers. The fourth adds eighteen cars for one hundred fifty dollars, a marginal cost of eight thirty-three a wash, below the price: produce them. The fifth adds fourteen cars for one hundred fifty, ten seventy-one a wash, above the price: do not. Both rules stop at four workers and ninety-six cars. Marginal cost per unit rises as marginal product falls, which is the link between unit six's rising marginal cost and this unit's falling marginal product, and the rules cannot disagree; if they seem to, a marginal was computed from an average.

What shifts a firm's demand for labor.

MIC 1209 Derived Demand and Shifts in Labor Demand

Labor demand is derived from product demand: a higher product price raises marginal revenue product at every hiring level, so more airplane orders raise the pay of assembly workers. Demand also shifts with technology, complementary or substitute factors, and the number of firms hiring. A wage change moves along the demand curve; only the four factors shift it.

Three entries on market power and the market wage: a firm that must cut price to sell more, computing its marginal revenue product, and where the wage comes from.

A firm with market power.

MIC 1210 Hiring Under Imperfect Competition

A firm with market power must cut price to sell more, so an added worker's output earns marginal revenue, not price. Its marginal revenue product is below the competitive value, and it hires fewer at any wage; the same worker is worth less to a monopolist. The rule is unchanged, and only the revenue side shrinks.

Computing it.

MIC 1211 Marginal Revenue Product with a Downward-Sloping Product Demand

When the product's price falls with output, compute total revenue at each number of workers as output times the price that output fetches, then marginal revenue product as the change in total revenue from each added worker, and compare it with the wage as before. Then compare the number hired with what a price-taking firm would hire on the same table at the initial price. The car wash's output of thirty, fifty-six, seventy-eight, ninety-six and one hundred ten cars sells at twelve, eleven, ten, nine and eight dollars, so total revenue is three sixty, six sixteen, seven eighty, eight sixty-four and eight eighty, and marginal revenue product is three sixty, two fifty-six, one sixty-four, eighty-four and sixteen. At a wage of one hundred fifty the third worker's one sixty-four is hired and the fourth's eighty-four is not: three workers, where a price taker at ten dollars hired four. Marginal revenue product is the change in total revenue, never marginal product times the new price, since the price cut on the earlier cars takes back most of what the fourth worker adds; and the wage did not change, the firm's demand for labor is lower.

Where the wage comes from.

MIC 1212 The Market Wage

Market labor demand is the horizontal sum of firms' demands; market supply, of individuals' supplies. The wage is set where they cross, and each competitive firm takes that wage as its flat supply curve: the market sets thirty an hour, the firm chooses hours at thirty. One buyer among many cannot move the wage, which is why marginal factor cost is constant.

Four entries on supply, shifts, and one buyer: the supply of labor, what shifts it, predicting from a shift, and monopsony defined.

The supply side.

MIC 1213 The Supply of Labor

Supplying labor means giving up leisure. A higher wage makes leisure dearer, the substitution effect, and the worker richer, the income effect, buying leisure, so an individual's supply can bend backward: one worker adds hours after a raise, another takes Fridays off. Supply to an occupation slopes upward as workers move in. Backward bending is about individuals, and the course draws market supply upward.

What shifts supply.

MIC 1214 Shifts in Labor Supply

Labor supply shifts with preferences for work against leisure, nonlabor income such as an inheritance, the price of complements such as child care, population, and expectations. Supply to one occupation also shifts with wages elsewhere and entry requirements; a licensing rule for barbers cuts the supply of barbers. A wage change moves along supply, and income from another source shifts it.

Predicting the wage.

MIC 1215 Predicting Wage and Employment from a Shift

Given an event in a competitive labor market, decide first whether it changes what workers are worth to firms, a demand shift, or how many are willing to work at each wage, a supply shift. Then apply the four cases: demand up raises both wage and employment, demand down lowers both, supply up lowers the wage and raises employment, supply down raises the wage and lowers employment. Four events in the market for construction workers. New residents raise the demand for houses: the product price rises, labor demand shifts right, wage and employment both rise. More women choose construction work: supply shifts right, wage falls, employment rises. Better training raises each worker's marginal product: demand shifts right, both rise. Factory-built framing substitutes for site labor: demand shifts left, both fall. Ask whether the event changes marginal product or product price, which is demand, or the number willing to work, which is supply, and an event that does both needs both curves; a wage change caused by one of these is a result, never the cause of a shift.

A market with one buyer.

MIC 1216 Monopsony

A monopsony is a market with a single buyer. A mining town's one employer, or the one hospital in town hiring nurses, faces the whole upward-sloping supply of labor, so to hire more it must raise the wage, and pay it to everyone already employed. Monopoly is one seller, monopsony one buyer, and a firm has monopsony power whenever supply slopes up.

Look at what you can now do. You can say that income comes from selling the services of labor, land and capital, and that a firm hires a worker for the revenue the output brings, never paying more than the last worker adds. You can compute marginal product from the change in total product, multiply by price or marginal revenue for marginal revenue product, and hire every worker whose product covers the wage. You can show that the hiring rule and the output rule are one, since marginal cost is the wage over marginal product, and name the four things that shift a firm's demand for labor. You can hire under market power, taking marginal revenue product as the change in total revenue, and derive the market wage from the sum of firms' demands and individuals' supplies. And you can describe why an individual's supply can bend backward while the market's slopes up, predict wage and employment from a shift by naming which curve moved, and define monopsony as one buyer facing the whole supply. Part two asks what one buyer does with that.