Chapter+11+-Labor+Market+and+the+Classical+Model

# Chapter+11+-Labor+Market+and+the+Classical+Model - Chapter...

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Unformatted text preview: Chapter 11 Study Guide To Accompany Macroeconomics: Theory and Policy By B. Modjtahedit Prepared by T. J. McCarthy and B. Modjtahedi University of California, Davis Key Points In the labor market households supply labor services, firms demand labor services. The unit of measurement for labor is typically the person-hour; for simplicity, the textbook instead measures labor in terms of the number of workers. The amount paid for a unit of labor is the nominal wage rate (W). Key Points Demand for labor: the amount of labor that firms are willing and able to hire at each wage rate The additional output produced as the result of hiring an additional worker is called the marginal product of labor (MPL). Law of diminishing returns: MPL decreases as more workers are hired The marginal benefit a firms receives from hiring a worker is the market value of that worker’s contribution to output, called the value of marginal product (VMP) VMP = P × MPL Being the marginal benefit, this is the highest the firm is willing to pay to the next worker hired. Key Points Firms hire labor up to the point where the marginal cost (given by the wage rate) is equal to the marginal benefit for the last worker, i.e., W= P × MPL Dividing through by the price level P, we get Where W/P is the real wage. With the price of labor measured in real terms, a firm’s demand-for-labor function is its MPL curve, and thus is downward-sloping MPL can change as the result of either technological progress or changes in the amount of capital and other resources used by the firm; this causes the demand-for-labor function to shift. W/P 1 2 3 4 5 10 20 30 40 50 60 70 80 90 100 L Key Points D L A reduction in the real wage results in an increase in the amount of labor demanded. This is a movement down the demand function. An increase in the real wage results in a decrease in the amount of labor demanded. This is a movement up the demand function. W/P 1 2 3 4 5 10 20 30 40 50 60 70 80 90 100 L Key Points D L An increase in the amount of capital or a technological progress will cause a rightward shift in the function. At any real wage, more labor will be demanded. Key Points Supply of labor: the amount of labor that households are willing and able to provide at each level of real wage. At any given real wage, households will supply a unit of labor if the real wage is higher than the marginal cost of providing that labor The change in the quantity of labor supplied that results from a real wage change has two components: the substitution effect and the income effect 1. Income effect: as the real wage increases, workers don’t have to work as many hours to earn the same amount of income as before (they can afford to consume more leisure), so the amount of labor supplied decreases 2. Substitution effect: as the real wage increases, the opportunity cost of leisure goes up, so households consume less leisure and supply more labor Empirically, the substitution effect dominates, so the supply of labor curve is upward-sloping W/P...
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## This note was uploaded on 04/03/2012 for the course ECN 001B 1b taught by Professor Baghermodjtahedi during the Spring '10 term at UC Davis.

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Chapter+11+-Labor+Market+and+the+Classical+Model - Chapter...

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