Professor C.L. Ballard
Fall Semester, 2007
KEY CONCEPTS FROM THE FINAL PART OF THE COURSE
I. Labor Markets
A. The benefit that a firm gets from hiring an extra unit of labor is the marginal revenue product
(MRP). The MRP is equal to the marginal product multiplied by the marginal revenue: MRP = (MR)
Marginal product is decreasing.
Marginal revenue is constant for a perfectly competitive firm,
and marginal revenue is decreasing for a firm that is not perfectly competitive.
marginal-revenue-product curve is downward sloping.
If the firm is a perfect competitor in its input
market, the cost to the firm of hiring an extra unit of labor is the wage rate.
Thus, the firm's optimal
input choice will involve hiring the number of workers at which the marginal revenue product is equal
to the wage rate.
As a result, the marginal-revenue-product curve is the firm's demand curve for labor.
The labor-demand curves of the individual firms are summed horizontally to get the market labor-
More generally, for any input, if the firm is a perfect competitor in the input market, the firm’s
optimal input choice will involve using the amount of the input at which the marginal revenue product
is equal to the price of the input.
As a result, the marginal-revenue-product curve is the firm’s demand
curve for the input.
B. The worker's labor-supply curve comes from the choice between consumption and leisure.
is a normal good
, so that increases in non-labor income lead to increases in leisure, and thus to a
reduction in labor supply.
If the wage rate rises, the substitution effect
leads to an increase in labor
supply (“I can’t pass up that kind of money”), but the income effect
works in the opposite direction (“I
can work less and still pay my bills”).
If the wage rate falls, the substitution effect leads to a decrease
in labor supply (“If that’s all I get paid, why should I bother to work?”), but the income effect leads to
an increase in labor supply (“I have to work harder just to keep food on the table”).
Thus, it is not
possible to tell, from theoretical considerations alone, whether labor supply will increase or decrease
as the wage rises.
The empirical evidence is that married men have very inelastic labor-supply curves
(elasticity close to zero), whereas married women probably have somewhat more elastic labor supply
(elasticity positive, but probably not extremely large, possibly 0.2 or 0.3 or 0.4 or 0.5).
If we combine
these, the weighted average of the labor-supply elasticities is probably fairly small—probably 0.1 or
0.2 or 0.3.
C. Market wages are determined by the interaction of labor supply and labor demand.
tend to be high when the demand curve is far to the right, either because the price of the product is
high or because the workers are very productive at the margin.
On the supply side, wages will be high
when the supply curve is farther to the left.
This can occur for positions that require special skills (i.e.,