Study this chapter to learn about labor markets, including topics on wage differentials, discrimination, and unions.
We have seen that a firm's demand for labor depends on the marginal product of labor and the price of the good the firm produces. We add the demand curves of individual firms to obtain the market demand curve for labor. The supply curve for labor depends
on variables such as population and worker preferences. Supply in a particular market depends on variables such as worker preferences, the skills and training a job requires, and wages available in alternative occupations. Wages are determined by
the intersection of demand and supply.
Once the wage in a particular market has been established, individual firms in perfect competition take it as given. Because each firm is a price taker, it faces a horizontal supply curve for labor at the market wage. For one firm, changing the quantity of labor it hires does not change the wage. In the context of the model of perfect competition, buyers and sellers are price takers. That means that a firm's choices in hiring labor do not affect the wage.
The operation of labor markets in perfect competition is illustrated in Figure 12.7 "Wage Determination and Employment in Perfect Competition". The wage W1 is determined by the intersection of demand and supply in Panel (a). Employment equals L1 units of labor per period. An individual firm takes that wage as given; it is the supply curve s1 facing the firm. This wage also equals the firm's marginal factor cost. The firm hires l1 units of labor, a quantity determined by the intersection of its marginal revenue product curve for labor MRP1 and the supply curve s1. We use lowercase letters to show quantity for a single firm and uppercase letters to show quantity in the market.
Wages in perfect competition are determined by the intersection of demand and supply in Panel (a). An individual firm takes the wage W1 as given. It faces a horizontal supply curve for labor at the market wage, as shown in Panel (b). This supply curve s1 is also the marginal factor cost curve for labor. The firm responds to the wage by employing l1 units of labor, a quantity determined by the intersection of its marginal revenue product curve MRP1 and its supply curve s1.
If wages are determined by demand and supply, then changes in demand and supply should affect wages. An increase in demand or a reduction in supply will raise wages; an increase in supply or a reduction in demand will lower them.
Panel (a) of Figure 12.8 "Changes in the Demand for and Supply of Labor" shows how an increase in the demand for labor affects wages and employment. The shift in demand to D2 pushes the wage to W2 and boosts employment to L2. Such an increase implies that the marginal product of labor has increased, that the number of firms has risen, or that the price of the good the labor produces has gone up. As we have seen, the marginal product of labor could rise because of an increase in the use of other factors of production, an improvement in technology, or an increase in human capital.
Figure 12.8 Changes in the Demand for and Supply of Labor
Panel (a) shows an increase in demand for labor; the wage rises to W2 and employment rises to L2. A reduction in labor demand, shown in Panel (b), reduces employment and the wage level. An increase in the supply of labor, shown in Panel (c), reduces the wage to W2 and increases employment to L2. Panel (d) shows the effect of a reduction in the supply of labor; wages rise and employment falls.
The Case in Point on technology and the wage gap points to an important social problem. Changes in technology boost the demand for highly educated workers. In turn, the resulting wage premium for more highly educated workers is a signal that encourages
people to acquire more education. The market is an extremely powerful mechanism for moving resources to the areas of highest demand. At the same time, however, changes in technology seem to be leaving less educated workers behind. What will happen
to people who lack the opportunity to develop the skills that the market values highly or who are unable to do so?
In order to raise wages of workers whose wages are relatively low, governments around the world have imposed minimum wages. A minimum wage works like other price floors. The impact of a minimum wage is shown in Panel (a) of Figure 12.9 "Alternative Responses to Low Wages". Suppose the current equilibrium wage of unskilled workers is W1, determined by the intersection of the demand and supply curves of these workers. The government determines that this wage is too low and orders that it be increased to Wm, a minimum wage. This strategy reduces employment from L1 to L2, but it raises the incomes of those who continue to work. The higher wage also increases the quantity of labor supplied to L3. The gap between the quantity of labor supplied and the quantity demanded, L3 − L2, is a surplus - a surplus that increases unemployment.
Figure 12.9 Alternative Responses to Low Wages
Government can respond to a low wage by imposing a minimum wage of Wm in Panel (a). This increases the quantity of labor supplied and reduces the quantity demanded. It does, however, increase the income of those who keep their jobs. Another way the government can boost wages is by raising the demand for labor in Panel (b). Both wages and employment rise.
Assuming that the market for construction workers is perfectly competitive, illustrate graphically how each of the following would affect the demand or supply for construction workers. What would be the impact on wages and on the number of construction