Principles of Economics- Mankiw (5th) 394

Principles of Economics- Mankiw (5th) 394 - 406 PA R T S I...

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406 PART SIX THE ECONOMICS OF LABOR MARKETS At first, it might seem surprising that the wage can do both these things at once. In fact, there is no real puzzle here, but understanding why there is no puzzle is an important step to understanding wage determination. Figure 18-4 shows the labor market in equilibrium. The wage and the quantity of labor have adjusted to balance supply and demand. When the market is in this equilibrium, each firm has bought as much labor as it finds profitable at the equi- librium 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. Hence, the wage must equal the value of marginal product of labor once it has brought supply and demand into equilibrium. This brings us to an important lesson: Any event that changes the supply or de- mand for labor must change the equilibrium wage and the value of the marginal product by the same amount, because these must always be equal. To see how this works, let’s con-
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