This chapter introduces you to labour markets, and the demand and supply of labour. You will also learn about the different outcomes when many firms or when only one firm are employing labour in a given market. How do firms value labour?
The marginal physical product, or marginal product (MP), of a worker is how much total output increases when that worker is hired.
The value of marginal product (VMP) of a worker is how much the total value of the output increases when that worker is hired. To find VMP, multiply together the worker's marginal product and the price the output sells for. VMP = MPL × PQ
where MPLº marginal product of labour, and PQº the price of the final output. Why do firms demand labour?
Firms demand labour because they want to produce some output. If there is no demand for the output, then the firm will not demand labour. We say that the firm demand for labour is a derived demand – that is, it only exists because the market demand for the firm's output exists first.
Because of the Law of Eventually Diminishing Returns, we know that as more labour is hired, the marginal product of labour declines, and the MPL curve slopes down. This downward slope is carried forward to the demand for labour curve, which also slopes down. How much labour should firms in perfectly competitive labour markets hire?
We assume that firms are profit-maximizers. So long as the value produced by labour exceeds its cost, the firm makes a net profit on that unit of labour. In other words, so long as the VMP of labour exceeds the wage, the firm will continue to employ more labour. It will stop employing labour when the two are equal. Profit-maximizing rule in the perfectly competitive labour market:
Hire labour until the VMP = wage
What is a monopsony?
A monopsony is a single employer of labour in a particular labour market. Monopsonies exist in small isolated logging towns where there is one logging company hiring loggers. Because there is only one employer, that firm sets the wage. It does not take the wage as given like the firms in perfectly competitive labour markets do. How does the monopsonist attract workers?
When the monopsonist wants to hire workers, it offers the lowest wage it can. However, not all workers are willing to work for that low wage. The monopsonist must offer higher and higher wages to attract more workers. If the firm pays the same wage to all workers doing the same job, it must raise the wages of the workers who responded to the low wage offers. Therefore, hiring one more worker costs more than that worker's wage – it also costs the raises that must be given to existing workers. What is the marginal labour cost?
The marginal labour cost is the additional cost to the firm as a result of hiring one more worker. It is the change in the total cost of labour divided by the change in the number of workers. What is the monopsonist's profit-maximizing rule?
The monopsonist is a profit-maximizing firm so it works to minimize its costs. The monopsonist's demand for labour is like any other firm's demand for labour – it is the firm's VMP and its value decreases as the amount of labour increases.
The supply of labour is the same as the supply of labour in the perfectly competitive labour market – the quantity of labour supplied increases as the wage increases.
The monopsonist uses essentially the same profit-maximizing rule as any other firm, but it sets wages as low as it can: Profit-maximizing rule in the monopsony labour market:
Hire labour until the VMP = marginal labour cost
Take the wage from the reservation wage of the last worker hired
- the firm hires labour where VMP = marginal labour cost
- the firm pays the lowest wage it can in order to attract the number of workers its needs
How do competitive labour markets and monopsony labour markets compare?
All for-profit firms, whether they operate in competitive labour markets or monopsony labour markets, work to maximize profits. However, the firm that hires workers from a competitive labour market faces a marginal labour cost that is constant at the market-determined wage.
The firm that hires workers from a monopsony labour market faces a marginal labour cost that increases as the number of workers hired increases. Therefore the monopsonist hires fewer workers than the firm in the competitive labour market, but the monopsony pays its workers less. What is labour market equilibrium?
The market demand for labour consists of all the firm demands for labour. At each wage rate, the market aggregates each firm's demand.  <![CDATA[<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif:: ::/sites/dl/free/0070889740/39505/cyber_fig13_1_375_189.gif','popWin', 'width=391,height=205,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (50.0K)</a>]]>
The market supply of labour consists of all the workers who are willing to work at each wage.
The equilibrium wage and quantity of labour are determined where the market demand equals the market supply of labour.  <![CDATA[<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif:: ::/sites/dl/free/0070889740/39505/cyber_fig13_2_250_224.gif','popWin', 'width=266,height=240,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (50.0K)</a>]]>
What is human capital theory?
Human capital is the pool of skills, education and work experience possessed by workers. Human capital generally makes workers more productive, thus increasing their marginal products.
Human capital theory holds that a worker's wages will be proportional to her stock of human capital. Workers with more human capital will make higher wages.
The decision of whether to invest in more human capital requires a cost-benefit investigation. The costs of acquiring human capital are incurred in the present – tuition, forgone wages. The benefits are reaped in the future – higher wages.
To compare future benefits with current costs, calculate the net present value of both into the foreseeable future. Generally, the longer the time frame, the greater the expected benefits from investing in human capital.  <![CDATA[<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif:: ::/sites/dl/free/0070889740/39505/cyber_fig13_3_300_306.gif','popWin', 'width=316,height=322,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (50.0K)</a>]]>
Over time, the wage differential – the difference in wages – between workers with more human capital and workers with less will decline as more workers choose to invest in human capital. The supply of workers with more human capital will increase, and the supply of workers with less human capital will decrease.  <![CDATA[<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif:: ::/sites/dl/free/0070889740/39505/cyber_fig13_4_300_158.gif','popWin', 'width=316,height=174,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (50.0K)</a>]]>
What is a labour union?
A labour union is a collective of workers who bargain with their employer to set wages and other working conditions. Labour unions derive their power by acting collectively. Their strongest tool is the strike, a complete withdrawal of labour. The employer must bargain with the union to achieve a mutually agreeable set of working conditions before the workers will return to their jobs. What are the union's goals?
A labour union works to improve the working conditions of its members, and particularly to raise its members' wages. When the union bargains a higher-than-market wage, it is as though a minimum wage has been established in the market.
- firms want to hire fewer workers
- more workers want union jobs
- firms can use more stringent hiring requirements
Research shows that most union workers earn about 50% more than non-union workers in the same type of employment. What is a winner-take-all labour market?
In a winner-take-all labour market, one worker earns a great deal more money than the other, similarly qualified workers. This is evident in entertainment and professional sports, where one actor or football player will earn a lot more money than others, even though they are not proportionately better at what they do than their colleagues.
A winner-take-all labour market is consistent with economic theory, as the winner earns much more revenue for her employer than her colleagues do. What are compensating wage differentials?
Compensating wage differentials are higher wages paid for jobs with relatively unattractive working conditions.
- dangerous jobs pay more than safe jobs
- night shifts pay more than day shifts
What is employer discrimination?
An employer who pays higher wages to one favoured group of workers is exhibiting employer discrimination. For the wage differential to be discrimination, the various groups of workers must be equally productive and have the same VMPs.
- males may make more than females for essentially the same work
Over time, the discriminatory wage differentials will disappear. If firms are minimizing costs, they will demand the lower paid workers and bid up their wages. They will also not hire the higher paid group, which would lead to a decrease in that group's wages. Understanding Questions
Do I understand this chapter? As a check to your understanding of the material in this chapter, you should be able to answer our questions.
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2003 McGraw-Hill Higher Education