Class 3 (Chapter 3)
Jan 26
The demand for labor is a derived demand.
Institutions: the social rules and customs by which people order
their everyday lives and by which society resolves conflicts over institutions.
These include laws and regulations as well as social norms and practices.
ASSUMPTION: firms maximize profits.
ASSUMPTION: The law of diminishing marginal returns, or as more labor is added, the marginal product of labor declines. This assumption results in a downward sloping demand for labor curve.
ASSUMPTIONS: If we assume competitive markets, we are assuming many buyers and sellers (homogeneous), perfect information, unfettered access to markets (freedom of entry and exit), and enforcement of contracts.
Profit maximization rule:
MR = MC (marginal revenue equals marginal cost).
In competitive markets, firms are price takers and so they decide output and minimize costs for any given output.
Minimization of costs rule (for each input) for the firm:
MRP = MP x MR (marginal revenue product equals the marginal product times
the marginal revenue).
For example, the marginal product of labor, MPL , is equal to
the change in output divided by the change in labor (all other inputs held
constant).
In competitive product markets, MR = P,
so MRPL= MPL x P.
In competitive input markets, ME, marginal expense of input,
equals the market price of the input.
For labor, MEL = W, the market wage rate.
In competitive product and labor markets, profit maximization
rule is:
MRP = ME (marginal revenue product of an input equals the marginal expense
of input).
Example of labor:
Since MRPL= MPL x P, which is the marginal product
of labor times the product price, or the value of the marginal product
of labor,
and MEL = W,
then MPL x P = W.
Example of capital:
MPK x P = C, or the marginal product of capital times the product
price equals the market price of capital.
The firm’s demand for labor curve in the short run is the marginal revenue product of labor curve (or the value of the marginal product curve in competitive markets). Given market wage, wc, firm hires Qc workers. Be able to show this graphically.
The market demand for labor curve in the short run is the summation of the labor demanded by all firms in a particular labor market at each level of the wage rate.
ASSUMPTION: Productivity goes with the job, not with the worker. There are many workers who can do the job with identical productivity. The productivity of the worker is affected by the job (i.e., by the amount of capital available).
Long-run demand: the firm must adjust all inputs so that the marginal cost of producing an additional unit of output is the same across all inputs. Or W / MPL = C / MPK.
Marginal rate of technical substitution: the rate at which labor
and capital can be substituted at the margin in producing a constant output.
MRTS = - (MPL/ MPK) At equilibrium, MRTS =
- (W/C)
Monopolistic product market: the firm as sole producer has impact on the price as well as the output. Firm faces a downward-sloping product demand curve. As output expands, the marginal revenue falls and MR< P. If the labor market is competitive, then
MRPL = MR x MPL = W.
Since monopolists reduce output to increase profits, the employment in a monopolistic product market will be lower than in a comparable competitive market. If the monopolist shares some of the rents (i.e., excess profits) with workers, then wages would exceed competitive wages.
Monopsonistic labor markets: the employer has some effect over the price of labor and faces an upward-sloping supply of labor curve. The marginal expense of labor exceeds the wage rate. MEL > W. So at equilibrium, MRPL = MEL. Notice that in a monopsonistic labor market, wages and employment levels are below comparable competitive levels (“monopsonistic exploitation”). Be able to graph this.
Impact of a mandated wage increase: there is a region within which a wage set by law or by a union can increase both wages and employment.
Example: graphing the effect of a payroll tax.
Shift the market demand curve down by the amount of the employer-paid
payroll tax. Be able to graph this.
Elasticity: the percentage change in quantity divided by the
percentage change in price.
For labor demand: the elasticity equals the % change in labor demanded
as wages change by 1%.
Demand curve is elastic if elasticity is greater than one;
Demand curve is inelastic if elasticity is less than one.
Marshall’s Four Laws of Labor Demand:
All else equal (cet par), the demand for labor is more elastic:
1. The greater the elasticity of the product demand.
2. The greater the elasticity of substitution of other inputs for labor.
3. The greater the elasticity of supply of other inputs.
4. The more important labor is in total costs. (“The importance of being
unimportant.”)
Exception to #4 (Hicks): Result reversed when it is easier for employers
to substitute other factors of production for labor than it is for consumers
to switch other products. So even a small share in total costs cannot protect
an input with good substitutes.
Implications of Marshall’s Four Laws:
The firm’s labor demand will be more elastic than the industry (market)
labor demand.
The labor demand in the long run will be more elastic than in the short
run.
Short-run labor demand elasticity: includes only the scale effect, so capital is assumed constant and there is no substitution effect.
The substitution effect: a measure of how employers change their production techniques in response to a wage change, holding output constant.
Long-run labor demand elasticity: includes both the scale effect and the substitution effect.